Student derivative lawsuits.

• Author: Kaufman, Adam Kyle

On October 10, 2005, the American University Board of Trustees announced that it had removed University President Benjamin Ladner. (1) The board had suspended Ladner in August, several months after receiving an anonymous tip that he had been charging most of his personal expenses to the University for years. (2) Despite his extensive misconduct, (3) the Board allowed Ladner to resign and collect a $3.7 million severance package. (4) Why did the Board of Trustees take so long to remove a president found to have flagrantly misused University funds, and then send him off with a golden parachute? The shocking answer appears to be that few of the trustees actually knew what the terms of Ladner's employment contract permitted, and thus most were unsure whether Ladner had even acted improperly. (5)

In this Comment, I argue that states could help avert financial scandals like the one at American University by adopting rules less protective of university boards. Specifically, I propose that states subject all nonprofit university boards to the same fiduciary standards as corporate boards and empower enrolled students to oversee their university boards. Part I addresses the current law concerning university oversight. Part II briefly discusses the responsibilities of corporate directors, with an eye toward how the American University trustees' behavior would be analyzed in the corporate context. After concluding that the American University trustees might well be found to have violated their fiduciary duties under corporate standards, I describe my proposal regarding enforcement of corporate oversight standards on university boards in Part III.

1. THE LAW GOVERNING UNIVERSITY BOARDS

   Universities can be organized under a variety of different forms, and the oversight regime imposed on universities largely depends on the form of organization chosen. I focus on one common organizational form for nonprofit universities (6): the nonprofit corporation. (7)

   Forty-eight states have a statute specifically designed to address formation and governance of nonprofit corporations. (8) Like a corporation, nonprofits formed under those statutes have boards charged with managing the organizations' affairs. (9) Unlike for-profit corporations, nonprofits may--but are not required to-have "members," who elect the board. (10) Insofar as the members choose the board, they are analogous to shareholders of a corporation. But unlike shareholders of a corporation, members do not have an equity stake.

   Most jurisdictions subject directors of nonprofit corporations to the same fiduciary standards that apply to directors of for-profit corporations. The District Court for the District of Columbia reached this result in the much discussed Sibley Hospital case, (11) as did the Georgia Supreme Court in Corporation of Mercer University v. Smith in deciding whether the trustees of a university satisfied their fiduciary duties in deciding to close a college. (12) In both those cases, courts adopted the corporate rule in order to protect the board from the higher standards imposed on trustees. (13) Within the next few years, New York and California codified the corporate fiduciary standard for nonprofit directors, and the Revised Model Nonprofit Corporation Act followed suit. (14)

   The corporate standard is a protective one for directors because courts follow the business judgment rule, which largely shields directors from personal liability in making discretionary business decisions. (15) The rule can be overcome, however, if a plaintiff shows that a director (1) acted in bad faith, (2) thought that the decision was contrary to the corporation's best interest, (3) was compromised by a conflict of interest, or (4) did not have enough information to make the decision in question. (16) Under Delaware case law, this final requirement for business judgment protection imposes a duty on the board to set up a system of monitoring to provide it accurate and timely information about the corporation. (17)

   Nonprofit corporations differ from their for-profit counterparts, however, in that fewer parties are allowed to police charitable boards. While the shareholders of for-profit companies have standing to sue for breaches of fiduciary duty, the stakeholders in nonprofit corporations generally do not. (18) In fact, the state attorney general is normally the only person with standing to sue nonprofit directors for breaches of duty. (19) But, as James Fishman has reported, "[s]taffing problems and a relative lack of interest in monitoring nonprofits make attorney general oversight more theoretical than deterrent." (20) Indeed, only thirteen state attorneys general oversee full-time charity divisions. (21)

   While certain states have granted standing to members, officers, or directors of nonprofit corporations, (22) these measures have done little to increase effective policing. Members still have little incentive to sue-both because of the collective action problem and because they lack any direct monetary stake--and directors have strong disincentives against suing each other. (23) While Fishman has found that the strict standing...