by Dr. Kevin Dean, President & CEO, Tennessee Nonprofit Network
You’ve dedicated your time, talent, and energy to a cause you believe in. You’re a nonprofit director or officer. Congratulations! Now, welcome to the wonderful world of personal liability. Unfortunately, sometimes we can have all the passion in the world, but that doesn’t stop bonkers things from happening, including lawsuits, criminal activity, and more. Unfortunately, you can’t “elevator speech your mission” your way out of angry former employee with a lawyer and a lawsuit.
Serving on a nonprofit board is often an exercise in idealistic optimism. You envision strategy sessions, fundraising triumphs, and inspirational annual reports. You do not envision sitting in a deposition room explaining why you didn’t read the financial statements closely enough. And there are two easy fixes to this: do your job well as a board member, and make sure your organization has insured you to protect you from a lawsuit.
One of the most consistent, cold-sweat-inducing surprises for a dedicated board member is the moment something truly awful happens—a catastrophic event, an employee scandal, or a devastating lawsuit—and the director finally asks, “Wait, where is our D&O insurance?“
The shock comes when the answer is: “We don’t have it.” Or worse: “We let it lapse to save on the budget.”
At that moment, the difference between the nonprofit’s bank account and your personal bank account ceases to be a theoretical distinction. Every hour spent in discovery, every attorney fee, and every potential settlement comes down to one fundamental truth: Your good intentions are lovely, but they don’t pay legal bills. And yes, as a board member, you can be held financially liable for the mistakes of your organization! (Cue the “WHAT?!” from several board members reading this.)
The law, in its infinite wisdom, demands that you perform your duties “in good faith; with the care that an ordinarily prudent person in a like position would use under similar circumstances; and in a manner the director [or officer] reasonably believes to be in the best interests of the corporation.”
If that sounds like something written by someone who never had to file their own taxes, you’re not wrong. But these three pillars—the duties of Care, Loyalty, and Good Faith—are the bedrock of responsible governance. Neglect them, and you invite trouble.
For instance, the duty of Care means you actually have to show up for meetings and read the financials. You can’t just rely on the Finance Chair, Brenda, because you assume she knows what she’s doing. If Brenda proposes investing all the organization’s reserves in a cryptocurrency based on cartoon dogs, and you nod along because you’re busy checking LinkedIn, you’ve likely breached your duty of Care. The law expects you to be a prudently ordinary person, not a financial savant, but it does expect you to pay attention.
The duty of Loyalty is simpler: Don’t be a self-dealing villain. If your nonprofit needs a new accounting firm, you can’t steer the contract to your brother-in-law, even if his firm does give you a great discount on your personal taxes. The corporation’s best interest must come first. (The penalty for this kind of thing is often called “intermediate sanctions,” which sounds much more polite than “The IRS is coming for you.”)
Protection: Because Good Intentions Don’t Pay Legal Bills
While acting according to these standards should give you immunity from liability—thanks, Revised Model Nonprofit Corporation Act—the grim reality is that even the most conscientious board can be sued. Why? Because people are litigious, and sometimes, well, things go wrong.
This is where the less-glamorous world of insurance comes in. You need protection, and that protection usually comes in the form of Directors & Officers (D&O) Insurance. (PS. If you need this, we have a great third party carrier for our members. Contact us!)
Think of D&O insurance as the financial equivalent of a Kevlar vest for your board. It covers both you, the individual director or officer, and the organization from claims arising from an alleged “wrongful act.”
What exactly is a “wrongful act”? The policies define it differently, but generally, it covers any “error, misstatement, omission, neglect, or breach of duty.” Essentially, if someone alleges you made a mistake while wearing your “director hat,” D&O steps in.
- A Realistic Example: A disgruntled volunteer alleges that the board neglected to review safety procedures, leading to an injury. They argue the injury was a direct result of the board’s “omission” to update the safety manual, a breach of the duty of Care. Or perhaps a major donor claims the annual report contained a “misleading statement” about the use of restricted funds. D&O covers the hefty cost of defending against that lawsuit, even if the claim is utterly baseless. Most nonprofits don’t have an extra $50,000 to $100,000 lying around for legal defense, so D&O is crucial for keeping the mission—and your personal assets—intact.
The beauty of D&O is that it pays out in two ways: it can indemnify the director (meaning the nonprofit pays the director back for their legal fees) or, if the organization can’t or won’t indemnify, the policy can pay the director directly. This is a small detail that becomes immensely important when the lawsuit itself alleges gross misconduct and the nonprofit’s bylaws prevent indemnification.
The IRS’s Favorite Tax: Intermediate Sanctions
While D&O covers the private lawsuits, you also have to worry about the federal government.
The IRS can impose an excise tax—the dreaded Intermediate Sanctions—on certain “disqualified persons” (like you, a director) who receive an “excess economic benefit” from the nonprofit. This is the IRS’s way of saying, “We see you trying to enrich yourselves under the guise of charity.”
- A Realistic Example: Your Executive Director needs a car allowance. The board, without getting an independent appraisal or market data, decides to give her an annual stipend that is double the regional average for similar positions because the ED is friends with the Board Chair. The IRS audits, determines the compensation is excessive, and slaps the ED (and possibly the directors who approved it) with a massive excise tax.
Some D&O policies include a limited sub-coverage for this, but it’s often a small “sublimit” and not a standard feature. Reviewing your policy to include this coverage is just another way to ensure your good intentions aren’t mistaken for tax evasion. After all, nobody wants to tell their spouse they owe the government five figures because they were too generous with the ED’s benefits package.
When HR Becomes a Liability: EPL Coverage
Finally, no nonprofit board member’s job is complete without worrying about employment. Enter Employment Practices Liability (EPL) Insurance.
The majority of D&O policies designed for nonprofits conveniently include this coverage. EPL protects the organization against claims arising from internal employment matters:
- Discrimination (e.g., denying a promotion based on age or gender).
- Wrongful Termination (e.g., firing a long-term employee without proper documentation and getting hit with a breach of implied contract suit).
- Harassment (e.g., failing to address a hostile work environment reported to the board).
- Retaliation (e.g., punishing a staff member for whistleblowing about Brenda’s dog crypto investments).
- A Realistic Example: Your organization downsizes, and a recently terminated, older employee files a lawsuit claiming age discrimination. They demand a jury trial. EPL pays for the cost of defending the organization in court. Without it, you’re stuck choosing between paying a potentially frivolous settlement and spending mission money on legal fees.
And here is a twist that only nonprofits would face: Even if you are an all-volunteer organization, many EPL policies wisely extend coverage to protect against claims filed by volunteers, not just paid employees. After all, if a volunteer feels they were unfairly terminated due to discrimination, the nonprofit still has a lawsuit to defend.
In short, governance is a serious business. The three duties are your roadmap, and D&O, including its cousins EPL and Intermediate Sanctions coverage, is your indispensable seatbelt. Read the documents, don’t break the law, and for the love of the mission, make sure your insurance policies are up to date—before you get that first, terrifying subpoena.