Nonprofit Genie (FAQs) | Insurance

The duty of obedience forbids acts outside the scope of corporate powers. The governing board of the organization must comply with state and federal law, and conform to the organization's charter, articles of incorporation and bylaws.

The duty of loyalty dictates that officers and directors must act in good faith and must not allow their personal interests to prevail over the interests of the organization.

The duty of care requires directors and officers to be diligent and prudent in managing the organization's affairs. The individuals charged with governing must handle the organizational duties with such care as an ordinarily prudent person would use under similar circumstances.

For many years, directors and officers of nonprofit organizations enjoyed a sense of invulnerability because their services were associated with a nonprofit and not an attractive target for litigation. Nonprofit board members who continue to believe they are invulnerable in the 1990s may be in for an unpleasant surprise.

The duties of corporate governance-obedience, loyalty and care-may seem high-minded and so much legalese. However, the importance of these responsibilities becomes crystal clear when a nonprofit board member is faced with a lawsuit alleging improper fiduciary oversight or improper oversight of employment practices resulting in allegations of sexual harassment or wrongful termination.

Nearly ninety percent of claims against boards of directors will involve some type of employment dispute. We also have learned that those ten percent of claims not involving employment disputes can be expensive and can happen to the smallest of organizations.

The claims involving employment disputes may allege wrongful termination, sexual or other harassment, sexual , racial or age discrimination, violation of the Americans with Disabilities Act (ADA), failure to hire, failure to promote, and just about any other allegation a disgruntled employee can make. The risk of getting such a lawsuit filed against the board of directors does not necessarily expand proportionately to the number of employees in an organization. Very often, the parties at odds in a wrongful termination lawsuit are the executive director and the board of directors. Many of these lawsuits can be avoided, or at least be dismissed in the early stages of the lawsuit, if the nonprofit follows its own personnel policies. But more on that later...

Other Allegations

While employment practices disputes generate the most lawsuits against boards of directors, another allegation of concern is breach of fiduciary duty. A lawsuit alleging breach of fiduciary duty could be brought by a donor, a concerned citizen, or the Attorney General. In short, this type of lawsuit alleges that the board of directors is not appropriately using and protecting the assets and resources of the nonprofit organization.

There are no laws in California that prevent individual nonprofit board members or a nonprofit organization from being sued. There are two state statutes which often are thought to offer protection of this nature, but a quick review of them shows why they offer little protection.

Corporations Code section 5047.5, a statute within the general provisions of the nonprofit corporate law, protects "uncompensated" directors. However, specifically excluded from the liability protection benefits of this section are:

actions alleging the director or officer is guilty of self-dealing,

actions maintained by the Attorney General,

liabilities arising from intentional, wanton or reckless acts, gross negligence, fraud, oppression or malice on the part of the director or officer, and

directors who are salaried employees.

In addition, and this is the most important part, before an uncompensated director or officer can claim protection under section 5047.5, the nonprofit corporation must maintain general liability insurance applicable to the claim with a minimum coverage of at least $500,000. As discussed above, a general liability policy almost never will be applicable to a claim against a director or officer. Unless the nonprofit organization recognizes that D&O coverage is the insurance that "applies to the claim," and purchases this coverage, there is no protection under this law.

Corporations Code section 5239, which pertains specifically to public benefit corporations, has similar problems. Its protections are not available if the director or officer receives any salary, fee or other consideration, other than a per diem or reimbursement for expenses.

Also, directors and officers must prove to the court that:

the act or omission was within the scope of the officer's or director's duties;

the director or officer acted in good faith; and

the act or omission was not reckless, wanton, intentional or grossly negligent.

As with section 5047.5, eligibility for protection afforded to volunteer directors and officers through section 5239 is contingent on the act or omission being covered by a policy of insurance. The most common type of liability insurance coverage purchased by nonprofits, a general liability policy, usually will not be applicable to a claim against a director or officer. In which case, this law offers little protection.

If you think this sounds like a Catch-22, you are right. There are no protections under California law for directors and officers of nonprofit organizations unless they have an insurance policy in place that applies to the claim. So, the catch is, if you have D&O insurance, the law may offer some help. If you don't have insurance that covers the claim, forget it. You'll get no help from the law.

And, if you happen to have D&O insurance that covers the claim, don't expect the present California law to offer much relief. Typically, the most expensive part of any lawsuit is determining the facts, such as whether the director or officer acted in good faith, and whether the act was simple or gross negligence. Once the point is reached where the court determines that the board member should not be held liable because he or she acted in good faith and that it was simple negligence, not gross negligence, most of the expenses of the lawsuit will already have been incurred.

Importantly, there is no California law which provides any protection, no matter how minimal, for the nonprofit organization itself. The protections discussed above apply only to individual directors. A lawsuit against a board of directors will typically name the individual directors and the organization as defendants. A D&O policy is the only protection available for the organization.

Finally, no state law can offer any protection for allegations of breaches of federal laws such as those covering racial, sexual, and age discrimination and discrimination against those with disabilities. As discussed earlier, a D&O policy may provide defense for such allegations until it is determined that the law was intentionally broken.

The promise by an organization to indemnify its board members is only as good as the amount of unrestricted and available assets of the nonprofit. When a nonprofit agrees to indemnify board members, it agrees that in situations where it is permitted to do so by law, it will pay to defend board members and possibly pay damages.

It is possible that some coverage for board service may be found under an individual's homeowner's policy, but the extent of that coverage depends on the specific wording of that policy. For example, it is not uncommon to find coverage under a homeowner's policy for accidents which cause "bodily injury" resulting in the course of volunteer activities. However, as discussed in an earlier section, insurance policies which cover "negligent acts" typically do not cover the "intentional actions" of a board of directors. In a manner similar to a general liability policy, a homeowner's policy may provide coverage for accidents, but as indicated earlier, these types of policies typically provide no protection for the activities involved in the governance of the agency.

Additionally, even if every board member individually has a homeowner's policy which provides coverage for his or her decisions as a board member , where is the coverage if the organization is named in the lawsuit? The organization would be required to mount its own defense.

"What about the Volunteer Protection Act of 1997?"

Federal legislation, known as the Volunteer Protection Act of 1997, was signed into law by President Clinton on June 19, 1997. This law has many of the same problems as the California laws discussed above. In particular, to receive any protection, the volunteer must prove in a court of law that he or she:

was acting within the scope of his or her responsibilities,

if appropriate or required, was properly licensed or certified,

did not cause the harm by willful, criminal, or reckless conduct or gross negligence, and

did not cause the harm by operating a motor vehicle, vessel, aircraft, etc.

Also, it provides for states to continue to maintain other criteria they have imposed on volunteers, such as the requirement in California that there is insurance in place that covers the claim.

This law does nothing to protect nonprofit organizations from being sued for actions of their volunteers. In fact, it makes it crystal clear that nonprofits are to be held responsible for the actions of their volunteers!

"Wait a minute. My board indemnifies board members in its bylaws. Isn't that adequate protection?"

The promise by an organization to indemnify its board members is only as good as the amount of unrestricted and available assets of the nonprofit. When a nonprofit agrees to indemnify board members, it agrees that in situations where it is permitted to do so by law, it will pay to defend board members and possibly pay damages.

There are two shortcomings here. First, nonprofits may not be permitted to indemnify board members against certain types of actions, such as allegations of self-dealing. For these types of allegations, the nonprofit may be prohibited from using charitable dollars in a board member's defense, whether or not the accusations are justified. And secondly, few nonprofits have sufficient unrestricted funds to mount an expensive and prolonged defense.

It is possible that some coverage for board service may be found under an individual's homeowner's policy, but the extent of that coverage depends on the specific wording of that policy. For example, it is not uncommon to find coverage under a homeowner's policy for accidents which cause "bodily injury" resulting in the course of volunteer activities. However, as discussed in an earlier section, insurance policies which cover "negligent acts" typically do not cover the "intentional actions" of a board of directors. In a manner similar to a general liability policy, a homeowner's policy may provide coverage for accidents, but as indicated earlier, these types of policies typically provide no protection for the activities involved in the governance of the agency.

Additionally, even if every board member individually has a homeowner's policy which provides coverage for his or her decisions as a board member, where is the coverage if the organization is named in the lawsuit? The organization would be required to mount its own defense.