We all know that a nonprofit board’s responsibilities include financial oversight, but do you have a clear understanding of why?
Financial oversight is linked to a greater set of responsibilities known as fiduciary duties.
Fiduciary duties are primarily governed by state law, which means they vary from state to state. However, they share the same foundational principles in every state. Together, the fiduciary duties provide a framework for appropriately stewarding resources, following legal standards, and addressing certain issues. When you agree to serve on a board of directors, you enter into a fiduciary relationship with the organization, meaning you are taking on certain legal duties and obligations.
This may sound intimidating, and the truth is, many board members do not wholly understand the legal obligations they are agreeing to when they accept a board position. However, fiduciary duties are nothing to be afraid of when they are well-understood. Here, I’ll share the essential information about fiduciary duties that every board member should know. Then, I’ll answer the question: what do fiduciary duties have to do with nonprofit accounting?
One note here – in general, fiduciary duties in nonprofit organizations are the same as fiduciary duties in for-profit entities. However, there’s one key difference. In a for profit, board members are responsible for maximizing profits. In a nonprofit, board members are responsible for maximizing a mission.
The Three Fiduciary Duties
Nonprofit fiduciary duties come in three forms: duty of care, duty of loyalty, and duty of obedience.
Duty of Care
Duty of care requires board members to act in good faith to further the nonprofit’s interests as a reasonable person would in the same circumstances. Fulfilling a duty of care includes devoting the necessary time to the organization to make reasonable and informed decisions. It also looks like asking questions, participating in deliberations, and exercising judgement. Financial oversight falls within duty of care. Usually, breaches in duty of care are not intentional; they are neglectful.
Duty of Loyalty
Duty of loyalty requires board members to act in the nonprofit’s best interests and put the nonprofit’s interest before any type of private interest. It is most often invoked when a nonprofit’s board faces a potential conflict of interest. Usually, board members can fulfill this duty by disclosing potential conflicts of interest and recusing themselves from decision-making processes pertaining to conflicts of interest. Most often, breaches of duty of loyalty are intentional fraud or self-dealing.
Duty of Obedience
Duty of obedience requires board members to adhere to the nonprofit’s mission and applicable law. The mission portion of this duty is unique to nonprofits, and refers to the mission as defined in the organization’s articles of incorporation, by-laws, and other governing documents.
Who Does Fiduciary Duty Apply to?
Fiduciary duty applies to board members at all levels, however, in some states, it applies differently depending on your position on the board. In most nonprofits’ by-laws, “officers” are defined as specific positions on the board such as “President”, “Vice President”, “Treasurer” and “Secretary”. Check your organization’s by-laws to understand how it uniquely structures its officer positions. Sometimes officers have stricter fiduciary responsibilities than general board members (who are often referred to as “directors”).
For example, in Colorado, a nonprofit can eliminate the personal liability of a director, but not an officer, for monetary damages due to a breach of a duty of care. To do this, a nonprofit would have to include a special provision in its articles of incorporation. That’s part of why it’s so important to read an organization’s articles of incorporation before joining a board.
Fulfilling Fiduciary Duties in Practice
There are many best practices that board members can have in place that relate to the fulfillment of fiduciary duties. They include:
- Have more than one board meeting per year. This relates to duty of care, and in particular, ensuring that you are devoting enough time to make reasonable and informed decisions.
- Set appropriate compensation for the ED. This relates to duty of care, in particular, ensuring you are acting in the interests of the mission.
- Review the 990 before it is filed. This relates to duty of obedience, complying with all relevant laws, and duty of care because reviewing the 990 helps you make reasonable decisions on behalf of the organization. Learn more about reviewing a form 990 here.
- Have a conflict of interest policy. Following a conflict of interest policy is essential to fulfilling the duty of loyalty. It is not illegal for a conflict of interest to arise within a nonprofit, but it is illegal to let a conflict of interest play out without guardrails.
- Ensure an annual financial audit is conducted and discuss the results with the audit firm. This part of the duty of care is a best practice and is required for certain organizations in many states. Learn more about what organizations are required to conduct an independent audit here.
Beancount exists to help nonprofit boards faithfully carry out the financial aspects of their fiduciary duties. If you’d like to have a conversation about working together, schedule a time to chat here.
So, How Does it Relate to Finances and Accounting?
The board’s role in overseeing finances directly stems from its fiduciary duties. For the most part, financial oversight is part of the duty of care. Fulfilling this responsibility includes:
- Requiring annual budgets and frequent financial reports.
- Ensuring that proper accounting systems and internal controls are in place to prevent fraud and embezzlement in the organization.
- Reviewing and approving budgets prepared by staff.
- Reviewing financial reports.
- Hiring a CPA to audit or review the organization’s annual financial statement.
How Does Fiduciary Duty Differ State-to-State?
Every state has slightly different legal frameworks for fiduciary duties. It’s important to get to know the laws in the state in which your organization is incorporated.
Fiduciary Duty in Colorado
In Colorado, the duty of care is expressly codified in the Colorado Revised Nonprofit Corporation Act (CRNCA). However, the duty of loyalty is based primarily on case law, though aspects of the duty have been incorporated into Colorado’s statutory rules on conflicting interest transactions. The duty of obedience is not expressly addressed in the Colorado statutes or case law. However, board members should still diligently carry out the organization’s mission and obey applicable laws, as failure to do so could implicate the duties of care or loyalty.
What happens if I fail to meet my fiduciary duty?
Board members take on a legal responsibility on which they are personally liable when they enter into a fiduciary relationship. However, organizations can take steps to protect their board members from liability. One way is including an indemnity right in their by-laws. Indemnity protects board members because it puts the onus on the organization to pay their legal fees if they are accused of breaching their fiduciary duties.
Nonprofits can secure “Directors and officers liability insurance” (D&O insurance), which covers the contractual right to provide legal assistance to board members and is generally affordable. This helps nonprofits avoid paying legal fees out of pocket. However, it is quite unusual for a board member to be sued as only state attorney generals and entities like the IRS have the authority to sue an individual nonprofit board member.
Resources and More
This blog post was written with the assistance of the following materials:
- BoardSource: Common Nonprofit Board Responsibilities
- Colorado Secretary of State: Fiduciary Duties of Nonprofit Directors
- Understanding Nonprofit Law & Finance: 48 Key Principles for Philanthropic Leaders by Erik Estrada
This article is for general informational purposes only and does not constitute professional accounting, tax, or legal advice. Tax laws, regulations, and accounting standards change frequently, and the application of rules can vary based on your organization’s specific facts and circumstances. Before acting on anything you read here, consult a qualified professional who can advise you based on your situation.
