The Desktop Guide is Quickly Becoming the Must Have Guide for Nonprofit Executives Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good, has quickly become the go-to guide for nonprofit executives and advisors. So what are people saying about the Guide? In the October 2007 edition of the The Federal Lawyer, New York lawyer George W. Gowen and nonprofit authority, wrote:
Some of our readers have followed the link to the Amazon.com Web site, but apparently have not bought the Guide. If they were turned off by the price, they should reconsider. One prominent attorney in the exempt organization field grabbed a review copy of the Guide and couldn't put it down. She has instructed a number of her clients to buy it, pointing out to them that for less than 1/2 hour of her billable time, they receive a lesson (and resource) that tells it like she would like it told. If you are starting a new charity, the Guide could save you thousands of dollars in legal fees by teaching you how to better utilize your legal counsel and framing the issues so you don't spin your wheels at $400 an hour. |
dispiriting, not the lawsuit. In fact, we applaud vigorous enforcement of the laws designed to protect charitable assets from abuse.
The facts involve the Monterey County AIDS Project (MCAP) and several former employees and board members. The controversy centers on endowment or restricted assets, which the AG claims evaporated. Of the $2.8 million referred to in the headline, $1.8 million is attributable to a bequest from Douglas Madsen, who left his Big Sur ranch to the MCAP upon his death in 1999. The AG alleges a judge, in keeping with Madsen’s wishes, ordered that the proceeds from the sale of the Big Sur property be placed in a housing endowment fund. The AG alleges that those funds, together with another million dollars in unrestricted funds, are gone. MCAP has since dissolved and its services consolidated with those of another organization.
The AG seeks the return of the money and an order barring 16 named individuals from ever serving as charity fiduciaries. Among those named are two former salaried executive directors. Also named are a number of former directors. Here the complaint gets interesting. Although the complaint doesn’t explicitly indicate that these individuals were uncompensated volunteers, the context suggests that some probably were. Take for example, Guy W. Blodgett, who is described as a director and the treasurer. Unlike the description of the two former executive directors, the description of Blodgett doesn’t refer to him as salaried. The former chairman of the board, however, is also referenced as an employee, suggesting a salary.
Of interest to other volunteer directors is
Daniel T. Yoshizato, who is referred to as a former member of the board. The complaint implies no specific
wrongdoing on Yoshizato’s part, but asserts that he had a duty to:
Mak[e...] reasonable inquiries when other MCAP officers and directors or de facto directors appeared to be engaged in wrongdoing including misappropriating funds or improperly using restricted charitable assets.
That same allegation is made against several other former directors. Among those also named are two former board members, one who was a Certified Public Accountant and another who was an attorney. The CPA was employed by MCAP as a bookkeeper and CPA. It is unclear whether the attorney provided legal services to MCAP.
Despite that flaw in the pleadings, the lawsuit is a potential blockbuster for several
reasons. First, the California
Attorney General’s pleadings reflect the same philosophy that is embodied in
the Internal Revenue Code’s trust fund tax penalty provisions. Those provisions impose liability on
responsible persons for income tax withholdings and the employee’s share of
FICA taxes if the employer fails to remit the payments. When those provisions
are used to impose a penalty for the taxes on directors who didn’t have
physical control of the checkbook, the IRS typically argues that the directors
either had knowledge or should
have known that the taxes weren’t being remitted, but the directors nevertheless
continued to authorize spending of corporate funds on other expenditures. That philosophy comes through loud and
clear in the California Attorney General’s filing, with the following phrase
repeated over and over:
During the relevant time period, defendant… held a position of authority and control over management of MCAP and its funds and assets by serving as an officer and/or a member of the board of MCAP, and has owed, and continues to owe fiduciary duties of care and loyalty to MCAP and its charitable beneficiaries. Defendant…also had a duty to act in good faith, and in the best interests of MCAP, including making reasonable inquiries when other MCAP officers or directors or de facto directors appeared to engage in wrongdoing including misappropriating funds or improperly using restricted charitable assets, which he failed to do. On information and belief, defendant… authorized, decided, and or/approved how funds from the Housing Endowment and contributions from California donors would be spent.
This language should frighten board members of what are in name boards, but in reality fundraising committees. It strongly suggests that the California Attorney General is willing to pursue volunteer directors who show up at board meetings and rubber stamp management's decisions. Reading between the lines, we view the California Attorney General as saying, “Look, you were aware that a significant portion of the funds held by this charity were restricted, but you did little or nothing to monitor how those funds were being spent. Moreover, if you were aware of actual expenditures, you should have recognized that the only way the expenditures could have been made was by tapping those restricted funds to finance expenditures that didn’t comply with the restrictions.”
That brings us to the second interesting aspect of the complaint. The California Attorney General seems to be requiring certain specific actions be taken before a board can claim that it has discharged its duties to protect restricted assets. The Attorney General comes pretty close to stating that a board must do the following to discharge its duties to protect restricted assets:
A. Develop and implement a corporate policy regarding how charitable and restricted assets and the income there from are to be used.
B. Discuss at board meetings how restricted assets and income is being protected and utilized and then reflect those discussions in meeting minutes. This requirement is consistent with recent judicial trends requiring that meeting minutes contain specific details rather than boilerplate statements.
C. Require management to put in place an accounting system that adequately records and reports how charitable assets are utilized.
D. Require management to institute internal controls that prevent the commingling of restricted assets with unrestricted assets and assets subject to different restrictions.
E. Make reasonable inquiries into questionable conduct. What is interesting about this requirement is that it is not expressly limited to known or outwardly visible questionable conduct. Maybe that is implicit, but the complaint can be read as imposing a duty to continuously examine all conduct to determine whether anything might be questionable.
Are these actions what the law requires? The California Attorney General certainly thinks so. California Corporation Code Sections 5231 and 5237 can be read to support such result. In particular Section 5231, requires reasonable inquiry. It sets up a defense to liability if the director relied on opinions, reports, or statements, including financial statements and other financial data, prepared by officers, directors, outside professionals, and board committees. But that defense requires reliance, which would seem to require affirmative action on the part of the board.
That brings us to the third notable aspect of the complaint. Normally, directors who find themselves facing personal liability haul out the business judgment rule for protection. That will be difficult to do if a court buys the California Attorney General’s enumeration of duties. The complaint isn’t phrased in terms of a breach of a broad duty of care. Instead, the breach is phrased in terms of specific duties—maintaining minutes and accounting records, conducting financial analysis, and making specific inquiries. That specificity will undercut any effort to mount a business judgment defense. It is a masterful strategic move on the part of the person who drafted the complaint.
Fifth, the complaint relies on Section 5237 of the California Corporation Code as a basis for liability. This is the provision that creates joint and several liable for directors who authorize certain prohibited distributions. There are two notable aspects to the California Attorney General's reliance on this provision. First, its prohibition can be viewed as part of the duty of care, but the provision's specificity again makes a defense rooted in the business judgment rule difficult. Second, we normally think of distributions as actions that would result in private inurement--in other words, the transfer of money or property from corporate solution to private interests without reciprocal consideration (i.e., a dividend). In this case, the AG apparently is construing the term "distribution" as a diversion of restricted assets or income from a permissible use to an impermissible one, albeit a charitable use.
Sixth, the complaint makes repeated reference to de facto directors. There aren’t enough facts stated in the complaint, but the California Attorney General apparently believes that individuals who are not serving as directors, but who exercised the sort of control and decisionmaking that is normally exercised by the elected directors, can be held accountable. This could have serious implications for lawyers, accountants, and other professionals who advise boards if the court buys the notion of a de facto director.
We will be very surprised if this matter is resolved through a court-rendered judgment following a trial on the merits; however, the significant dollar amounts involved may force the defendants to go to the mat. We will not be surprised if the defendants are forced to make a substantial payment of money to make the matter go away. This strikes us as one of the best advertisements for D & O insurance that we have seen. It also may offer a lesson why indemnification can be worthless.
The lesson for other boards, including boards of tony cultural institution, could not be clearer. The California Attorney General is now prepared to argue that boards have specific tasks that they must be perform. Failure to do so can result in assertions of personal liability if a failure to perform those tasks leads to loss. Fundraising responsibilities are no longer the only duties that many individuals will be assuming when they join a board.
Is this the case of the year? Well there are still seven months to go before year-end, but it could be a contender for that coveted title.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good."
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