Many nonprofit board members assume that because they are volunteers, they carry no real legal risk. Volunteering can protect you. It does not excuse you. Here is what every board member should know about nonprofit board liability: who enforces the rules, what protects you, and where the real risk lies.
This is a general overview, not legal advice. Laws vary by state, so talk to your own attorney about your situation.
Yes, You Have Legal Duties
A board seat is not an honorary title. State law requires directors to act with care and loyalty, and many courts and governance authorities add a duty of obedience to the mission. We cover all three in Nonprofit Board Fiduciary Duties. These duties apply whether you are paid or not.
Who Enforces the Rules
- The State Attorney General. The primary enforcer. Charitable assets must be used for charitable purposes, and the attorney general makes sure they are. The office can investigate, sue directors, and ask a court to remove them or block transactions. In 2002, Pennsylvania’s attorney general won an injunction stopping the Hershey Trust’s planned sale of its controlling stake in Hershey Foods.
- The IRS. It enforces the tax rules that come with exempt status, and it asks the board direct governance questions on the Form 990, which is public.
- Members and Fellow Directors. In many states, they can sue on the organization’s behalf.
- The Nonprofit Itself. New leadership, a receiver or a bankruptcy trustee can sue former directors. It is also the lawsuit many volunteer protections may not cover.
What Brings Scrutiny?
Scrutiny can start in many ways: a complaint from a former employee or donor, a news story, an IRS review of filed returns, or an investigation into a related party. Some actions, like attorney general lawsuits, play out in public. IRS examinations are generally confidential. Either way, being investigated can be slow and expensive, even for directors who are never found liable.
Your Form 990 is public, and it is often where outsiders look first. Our guide to Red Flags and What They Mean shows what they look for.
What Protects You From Liability
- The Business Judgment Rule. Courts generally will not second-guess a good faith, informed, conflict-free decision, even one that turns out badly. It protects your process, not your outcomes.
- The Volunteer Protection Act. Federal law shields unpaid volunteers acting within their responsibilities from many claims by outsiders. It does not cover gross negligence, willful misconduct or crimes, and it does not protect you from a lawsuit by the nonprofit itself.
- D&O Insurance. An important financial protection that can pay defense costs and covered claims, which matters because legal fees alone can be ruinous. Ask to see the policy and have the broker explain what it excludes.
- Indemnification. Your bylaws may promise to cover your costs, but that promise is only as good as the organization’s bank account, and it rarely covers bad faith.
Where Board Members Actually Get Hurt
Honest mistakes rarely lead to personal liability. These four situations can:
- Improper Insider Transactions. Deals between the nonprofit and a board member, an executive or their families. Disclosure, recusal and fair terms are the minimum safeguards, but they do not make every insider deal acceptable, and private foundations face stricter self-dealing rules.
- Excess Benefit Transactions. When an insider is overpaid, the IRS can impose heavy taxes on the insider, and board members who knowingly participate in an improper transaction can also face personal tax penalties.
- Ignoring Obvious Problems. Delayed audits, an unread Form 990, one person controlling the money. Not paying attention is not a defense.
- Unpaid Payroll Taxes. If a nonprofit fails to pay over the taxes it withheld from employee paychecks, the IRS can hold anyone responsible for paying them, who willfully failed to do so, personally liable for 100 percent of the unpaid amount. Directors who control which bills get paid can qualify.
The Short List
- Read the bylaws and the Form 990 before it is filed. Start with How to Read a Form 990.
- Disclose conflicts every year, and step out of any vote where you have one.
- Set executive pay using comparable data, and document it.
- Ask at every meeting whether payroll tax deposits are current.
- Know what your D&O policy covers.
For more, see What Every Trustee Should Know and Give, Get, Govern, and our Form 990 resource center.
This article is for general educational purposes and is not legal or tax advice. Laws vary by state. Consult your own attorney about your situation.
