Liability for Directors of Nonprofit Corporations, 0317 SCBJ, SC Lawyer, March 2017, #44

• Author: John H. Warren III, J.

Liability for Directors of Nonprofit Corporations

No. Vol. 28 Issue 5 Pg. 44

South Carolina Bar Journal

March, 2017

John H. Warren III, J.

Introduction

Lawyers are often asked to serve on boards of nonprofit corporations and if they do so, they will often be asked by other directors about the potential individual liability of a director for actions of the nonprofit, for actions of the director and for actions of other directors. It is essential, therefore, that such lawyers understand the risks involved. It is the purpose of this article to further that understanding.

The risk/reward analysis resolves itself into the question of whether (1) the risk of the liability to the director outweighs the benefit of the service to the public, or (2) the benefit of the service to the public outweighs the risk of liability to the director.

Directors of nonprofit corporations must have a thorough understanding, first, of the duties of such a director because it is for a breach of those duties that a director may be sued individually, putting the director's personal assets at risk. Insurance companies providing coverage for directors of nonprofit corporations emphasize this concept. The website of one insurance company states that such potential liability "[C]ould threaten an individual's livelihood and personal fortune" and that directors owe "fiduciary duties to the nonprofit organization and its grantees and donors."^[1] The website of a second insurance company brings the liability closer to home, perhaps, by stating that such potential liability threatens "your money, your house, your boat."^[2]

Although a director of a nonprofit corporation has duties and standards of conduct to adhere to, a system of statutory protection does exist in South Carolina for such a director. This system is more protective of a director of a nonprofit corporation than the system protecting a director of a business corporation. Liability insurance exists too, enabling the public benefit to be achieved by directors serving nonprofits to outweigh the risk of personal liability.

Duty of care as interpreted by state law

A director of a nonprofit corporation has two duties under South Carolina law: (1) a duty of care and (2) a duty of loyalty^[3] with a third related duty being to protect the federal tax exempt status of a nonprofit corporation. This article primarily addresses the duty of care.

Three primary South Carolina statutory provisions address the duty of care of a director of a nonprofit corporation: S.C. Code Ann. Sections 33-31-830, 33-31-202 and 32-31-834.

S.C. Code Ann. Section 33-31-830

The governing statutory authority affecting directors is codified in Section 33-31-830 and is based on the second edition of the Model Nonprofit Corporation Act approved by the Committee on Nonprofit Corporations of the American Bar Association in 1987.^[4] Section 33-31-830(a), entitled "General Standards for Directors," provides that a director shall discharge his duties as follows: (1) in good faith;

(2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and

(3) in a manner the director reasonably believes to be in the best interests of the corporation.^[5]

Subsections (1) and (2) constitute the duty of care and the standard is a negligence standard involving an analysis of the specific language of the section, including "a prudent person," "in a like position" and "under similar circumstances." Id.

Section 33-31-830(d) provides that a director meeting the standard of Section 33-31-830(a) is not liable to the corporation, a member or any other person if complying with this section.

S.C. Code Ann. Section 33-31-202

Section 33-31-202(b)(2) provides that no director is personally liable for monetary damages for breach of any duty to a nonprofit corporation or its members, excepting, with respect to the duty of care, "acts not in good faith or intentional misconduct or knowing violation of law."

The protection in this Section has both positive and negative differences from the protection in Section 33-31-830. On the positive side, the protection from liability here is not only against negligence, but also against gross negligence, because intentional misconduct would be a higher standard than gross negligence.^[6] On the negative side, the protection in Section 33-31-202(b) applies only to a breach of any duty to the corporation or its members, arguably excluding third party claims, and applies only to monetary damages, not to equitable remedies. The South Carolina Reporter's Comments recognize, again, that extending protection to grossly negligent conduct is founded on the concept that directors in these circumstances are unpaid volunteers. This is a reflection of the legislative determination that unpaid volunteers, giving of their time and often their money to an entity whose purpose is a public benefit, deserve a higher level of protection than directors of for-profit corporations, whose purpose is primarily financial and whose directors are usually paid for their service.

S.C. Code Ann. Section 33-31-834

Section 33-31-834 is not a part of the Model Act but was included...