Good Governance of Non-Profit Entities

Monday, June 11, 2007
Contributed by: Thomas R. Dixon, Jr.

Dedicated and committed board members are essential to good management of any charity. If you have volunteered to serve on the board of a non-profit entity, you are performing an important service for the entity and for the public. Service on a board of directors of a non-profit entity also comes with responsibilities to the public and to the organization's donors. Donors want to be sure that the organization spends their contributions wisely and in accordance with the organization's goals and mission. The public wants non-profit organizations to live up to the public's expectations that the non-profit will act in ways that further its goals and missions rather than some private purpose. If the non-profit corporation has obtained an exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code, then the Internal Revenue Service expects its directors to live up to the IRS's standards for good governance of a 501(c)(3) Organization.

As the Internal Revenue Service states in its publication "Good Governance Practices for 501(c)(3) Organizations," boards of directors of non-profits "should be composed of persons who are informed and active in overseeing a charity's operations and finances." In agreeing to serve on a non-profit board, you have agreed to keep informed about the organization's activities and to be active in overseeing its operations and finances.

As for the standard of care applicable to non-profit directors, the IRS summarizes it as follows:

Due Diligence

The directors of a charity must exercise due diligence consistent with a duty of care that requires a director to act:

  • In good faith;
  • With the care an ordinarily prudent person in a like position would exercise under similar circumstances;
  • In a manner the director reasonably believes to be in the charity's best interests.

Directors should see to it that policies and procedures are in place to help them meet their duty of care. Such policies and procedures should ensure that each director:

  • Is familiar with the charity's activities and knows whether those activities promote the charity's mission and achieve its goals;
  • Is fully informed about the charity's financial status; and
  • Has full and accurate information to make informed decisions.

Board members should not engage in self-dealing and should avoid conflicts of interest. Moreover, the directors owe the non-profit corporation a duty of loyalty. This duty requires the directors to act in the best interest of the non-profit corporation, rather than in the personal interest of the individual director or some other person or organization.

Under Texas law, directors of non-profit corporations are generally not liable for errors or mistakes in judgment if such actions were taken in good faith and if the board members were not grossly negligent. Sometimes this standard is referred to as the "business judgment rule." Acting with the due diligence required by the IRS policies is strong evidence of the exercise of good business judgment.

The IRS also states that a non-profit should have a policy of "transparency"-in other words, making "full and accurate information about its mission, activities and finances publicly available." Finally, the IRS points out that directors must be "good stewards of the charity's financial resources," operating in accordance with an annual budget approved by its board of directors and ensuring that an independent auditor conducts an annual audit.

When directors fail to act with due diligence or to exercise good business judgment, they can jeopardize the non-profit corporation's tax exempt status or even subject themselves to individual liability to creditors of the non-profit organization. So, acting with due diligence and exercising good business judgment is important both to the non-profit organization that you serve as a director as well as to you individually.

Underwood's lawyers have significant experience in helping officers and boards of directors of non-profit entities pursue their goals and further their missions by adopting and following good management practices that evidence due diligence and business judgment. Contact Ray Dixon at (806) 379-0305 or at Ray.Dixon@uwlaw.com for more information.

This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author's law firm or its individual partners.