Nonprofit leaders have more on their plates than ever before and it can be easy to inadvertently stumble over governance requirements established in your organization’s articles of incorporation, bylaws, and board policies. Governance issues tend to build up gradually and are not always immediately apparent. Failure to proactively review and maintain your organization’s governance documents can lead to significant time delays for desired activities and result in an expensive cleanup process. This article highlights five nonprofit governance pitfalls we have seen recently involving Oregon nonprofits, how to correct them, and the potential consequences of not correcting them.
Pitfall #1: Not Abiding by Board Composition Requirements
The Oregon Nonprofit Corporation Act (the “Act”) provides nonprofits with flexibility in establishing board composition requirements. Accordingly, some nonprofits include in their bylaws qualifications that must be satisfied for an individual to be a properly seated director (e.g., employed in a certain industry). Establishing director qualifications is permitted under the Act, but these additional requirements can become problematic if the board fails to ensure elected directors satisfy the qualifications during their board service.
How to Correct
One option is to limit the board to qualified directors who satisfy the documented qualifications and remove any unqualified directors. If after the removal of all unqualified directors the board fails to possess the minimum number of qualified directors, the remaining qualified director(s) should appoint additional qualified directors. Alternatively, the qualified directors may amend the bylaws to remove the director qualifications and ratify past elections and actions of the board.
Consequences of Not Correcting
Failure to correct an improperly composed board could lead to previous board actions being challenged and determined null and void if quorum and voting thresholds were not satisfied. Additionally, the board could be limited in its ability to act on a prospective basis until additional qualified directors are properly appointed and there are a sufficient number of directors to meet applicable quorum and/or voting requirements.
Pitfall #2: Not Following Established Board Election Procedures
Like establishing director qualification requirements, the Act gives nonprofits discretion to establish their board election procedures. At a basic level, a nonprofit should understand who is responsible for electing its board of directors. If a nonprofit has members within the meaning of the Act (“statutory members”), they are often responsible for appointing all or a majority of the board. If a nonprofit does not have statutory members, the board elects its own directors, though it may occasionally assign that right to a third party. Beyond identifying who elects the board, a nonprofit should ensure that there are enough attendees to satisfy quorum requirements or the nonprofit may fail to meet the required minimum voting threshold to elect a director. It should not be assumed that a quorum is always a simple majority of those entitled to vote or that approval requires only a majority of a quorum. Some organizations impose higher attendance voting thresholds specifically for board elections.
How to Correct
If the nonprofit did not properly elect one or more directors, it should hold a new election. Alternatively, the organization may recognize only the properly elected individuals as the board of directors moving forward and remove any improperly elected directors.
Consequences of Not Correcting
If a nonprofit fails to elect its board properly, it risks a third-party contesting board actions or a court declaring board actions null and void, unless a duly elected board ratifies or retakes those actions. To determine which actions the board should ratify or retake, the nonprofit should confirm that the body responsible for electing the board duly elected the minimum number of directors required at the time of the board action. The nonprofit should also confirm that all quorum and voting thresholds were satisfied at the time of the board action.
Pitfall #3: Not Appreciating the Distinction Between Advisory Committees and Board Committees
Under the Act, a nonprofit can form one or more advisory committees or board committees:
- An advisory committee is often made up of directors and non-director community members and is tasked with advising the board on one or more topics (e.g., a finance committee), but an advisory committee is not authorized to act on behalf of the board.
- A board committee, on the other hand, is delegated specific authority to act on behalf of the board in certain situations or for one or more defined matters (e.g., an executive committee). Only directors serving on a board committee may vote on committee matters.
When forming a committee, the board should clearly designate whether the committee is a board committee or an advisory committee and outline the committee’s authority. This helps ensure the committee acts within its delegated authority. Understanding the difference between an advisory committee and a board committee also helps ensure board and committee actions are properly documented and approved.
How to Correct
For an action taken outside the scope of a committee’s authority, the board should ratify the committee action if the board determines that the action is in the best interest of the nonprofit. For actions taken within the scope of a committee’s authority that were not properly approved (e.g., non-directors voting on a board committee action), the committee should ratify the action following the correct voting procedures.
Consequences of Not Correcting
If a committee acted outside of its delegated authority, or if a committee did not properly approve an action within its delegated authority, such action could be challenged as improper and be considered null and void.
Pitfall #4: Not Maintaining a Current Membership List
Under the Act, a nonprofit with statutory members is required to maintain a membership list: a record of its members that includes each member’s contact information and membership class. It is critical that a nonprofit with statutory members maintain and regularly update its membership list to ensure that members can be properly notified in the event of an upcoming member meeting or the need for a member action.
How to Correct
If a nonprofit with statutory members does not have a current membership list, it should establish one. If an existing membership list is out of date, it should be updated by removing members that have resigned or have failed to remain a member in good standing and adding new members that have joined since the membership list was last updated. Additionally, member contact information should be regularly updated to the extent that the nonprofit knows documented contact information is incorrect.
Consequences of Not Correcting
A nonprofit’s failure to maintain a current membership list can result in a challenge to the validity of a member action or the votes of a member meeting if the board failed to notify all members entitled to vote. Actions taken at a meeting where insufficient notice was given can be considered null and void. Failure to maintain a current membership list can also lead to inquiries regarding whether proper counts were used to determine quorum and voting requirements.
Pitfall #5: Not Following Conflict of Interest Procedures
Both the Act and the IRS have rules and regulations applicable to nonprofit directors that concern conflict of interest transactions. A best practice for nonprofits is to memorialize conflict of interest requirements in a formal conflict of interest policy adopted by the board. Those not familiar with the rules related to identifying, disclosing, approving or denying, and documenting a conflict of interest transaction may inadvertently violate state and/or federal law.
How to Correct
If a conflict of interest is identified or disclosed after a transaction has been entered by the nonprofit, the transaction should be ratified by the board’s independent directors: those directors without a conflict of interest. A conflict of interest transaction should be ratified by following the procedures outlined in the nonprofit’s conflict of interest policy, and a conflict of interest transaction should only be ratified if the independent directors determine that the transaction is in the best interest of the nonprofit after gathering and reviewing sufficient information from the conflicted directors.
Consequences of Not Correcting
A nonprofit’s failure to identify, review, approve, and memorialize a conflict of interest transaction may lead the IRS to determine that the organization engaged in an impermissible excess benefit transaction, conferred an impermissible private benefit, or permitted impermissible private inurement. Any of these findings could cause the nonprofit to lose its tax-exempt status. Furthermore, the IRS could assess an excise tax against the organization’s independent directors (those who approved the transaction) and the conflicted director, based on the amount of any excess benefit the nonprofit provided. In addition to IRS penalties, the Oregon Department of Justice Charitable Activities Section may investigate and levy its own penalties against the nonprofit and its board.
Nonprofit Governance Guidance
Nonprofit governance requirements can be nuanced, and even minor oversights may create challenges for your organization. If you have questions about your organization’s governance documents or board practices, please contact me or any of member of our nonprofits team to help you evaluate compliance and address potential issues.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
