Traditionally, the officers and directors of nonprofit corporations performed their duties with little if any risk of personal legal liability. In recent years, a number of lawsuits have attempted to impose personal liability on such officers and directors. In some cases, directors are sued because of statutes that provide limited legal immunity to churches.
As a general rule, directors are not responsible for actions taken by the board prior to their election to the board (unless they vote to ratify a previous action). Similarly, directors ordinarily are not liable for actions taken by the board after their resignation. Again, they will continue to be liable for actions that they took prior to their resignation.
A number of state laws permit nonprofit corporations to amend their bylaws to indemnify directors for any costs incurred in connection with the defense of any lawsuit arising out of their status as directors. While there are several theories of liability related to officers, directors, and trustees, in this article, we’ll focus on breach of fiduciary duty of care.
Key point. Church board members have a fiduciary duty to use reasonable care in the discharge of their duties, and they may be personally liable for damages resulting from their failure to do so.
What Jim Bakker taught us
The board members of business corporations are under a duty to perform their duties “in good faith, in a manner they reasonably believe to be in the best interests of the corporation, and with such care as an ordinarily prudent person in a like position would use under similar circumstances.”
This duty commonly is referred to as the “prudent person rule” or the “duty of due care.” In recent years, some courts have extended this duty to the board members of nonprofit corporations.
A ruling of the bankruptcy court in the PTL ministry bankruptcy case addressed the liability of directors and officers. Heritage Village Church and Missionary Fellowship, Inc., 92 B.R. 1000 (D.S.C. 1988).
The court agreed with the bankruptcy trustee that televangelist Jim Bakker (as both an officer and director) had breached his legal duty of care to PTL. It quoted a South Carolina statute (PTL was located in South Carolina) that specifies the duty of care that a director or officer owes to his or her corporation:
A director or officer shall perform his duties as a director or officer, including his duties as a member of any committee of the board of directors upon which he may serve, in good faith, in the manner he reasonably believes to be in the best interest of the corporation and of its shareholders, and with such care as an ordinary prudent person in a like position would use under similar circumstances. Quoting S.C. Stats. ANN. § 33 13 150(a).
The court, in commenting upon this provision, observed:
Good faith requires the undivided loyalty of a corporate director or officer to the corporation and such a duty of loyalty prohibits the director or an officer, as a fiduciary, from using this position of trust for his own personal gain to the detriment of the corporation. In this instance, there are no shareholders of the corporation; however, even though there are no shareholders, the officers and directors still hold a fiduciary obligation to manage the corporation in its best interest and not to the detriment of the corporation itself.
The court concluded that:
“the duty of care and loyalty required by [Bakker] was breached inasmuch as he, 1) failed to inform the members of the board of the true financial position of the corporation and to act accordingly; 2) failed to supervise other officers and directors; 3) failed to prevent the depletion of corporate assets; and 4) violated the prohibition against self-dealing.”
With respect to Bakker’s defense that his actions had been “approved” by the board, the court observed that Bakker “exercised a great deal of control over his board” and that “a director who exercises a controlling influence over co-directors cannot defend acts committed by him on the grounds that his actions were approved by the board.”
The court acknowledged that officers and directors cannot be “held accountable for mere mistakes in judgment.” However, it found that “the acts of [Bakker] did not constitute mere mistakes in judgment, but constituted gross mismanagement and a neglect of the affairs of the corporation.
Clearly the salaries, the awards of bonuses and the carte blanche exercised over PTL checking accounts and credit cards were excessive and without justification and there was lack of proper care, attention and circumspection to the affairs of the corporation. [Bakker] breached [his] duty to manage and supervise ….”
In support of its conclusions, the court cited numerous findings, including the following:
- Bakker failed to require firm bids on construction projects though this caused PTL substantial losses;
- capital expenditures often greatly exceeded estimates, though Bakker was warned of the problem;
- Bakker rejected warnings from financial officers about the dangers of debt financing;
- many of the bonuses granted to Bakker were granted “during periods of extreme financial hardship for PTL”;
- Bakker “let it be known that he did not want to hear any bad news, so people were reluctant to give him bad financial information”;
- “it was a common practice for PTL to write checks for more money than it showed in its checkbook; the books would often show a negative balance, but the money would eventually be transferred or raised to cover the checks written—this ‘float’ often would be three to four million dollars”;
- most of the events and programs at PTL that were made available to the public were operated at a loss; since 1984, “energy was placed into raising lifetime partner funds rather than raising general contributions”;
- Bakker “during the entire period in question, failed to give attention to financial matters and the problems of raising money and cutting expense.”
Though at the time of Bakker’s resignation in 1987 PTL had outstanding liens of $35 million, and general contributions were in a state of decline, “millions of dollars were being siphoned off by excessive spending.” Such spending, noted the court, “is shocking to the conscience the extent that it is unbelievable that a religious ministry would be operated in such a manner.”
The court concluded that “Mr. Bakker, as an officer and director of PTL … approached the management of the corporation with reckless indifference to the financial consequences of [his] acts. While on the one hand [he was] experiencing inordinate personal gain from the revenues of PTL, on the other hand [he was] intentionally ignoring the extreme financial difficulties of PTL and, ironically, [was], in fact, adding to them.” To illustrate, Bakker accepted huge bonuses at times of serious financial crisis at PTL. “Such conduct,” noted the court, “demonstrates a total lack of fiduciary responsibility to PTL.”
The court emphasized that “trustees and corporate directors for not-for-profit organizations are liable for losses occasioned by their negligent mismanagement.”
Investing church funds
Those who serve on a board of directors, whether for a church or any other organization, have a legal duty to perform their duties in good faith, in a manner they reasonably believe to be in the best interests of the corporation, and with such care as an ordinarily prudent person in a like position would use under similar circumstances. This duty commonly is referred to as the “prudent person rule” or the “duty of due care.”
The fiduciary duty of due care often is set forth in a state’s nonprofit corporation law. To illustrate, the Revised Model Nonprofit Corporation Act, which has been enacted in a small but growing number of states, contains the following language:
A director shall discharge his or her duties as a director … (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.
In discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel, public accountants or other persons as to matters the director reasonably believes are within the person’s professional or expert competence …. Revised Model Nonprofit Corporation Act § 8.30.
This duty of due care applies to the investment of corporate funds. However, directors are not accountable for every bad investment they authorize. They are not held to a standard of perfection. Rather, they are accounTable only if an investment decision was not based on “the care an ordinarily prudent person in a like position would exercise under similar circumstances.”
The courts have been reluctant to impose liability on directors for an exercise of poor judgment. One state Supreme Court, in language that has been quoted by several other courts, observed:
[There is] a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption.
Four steps to reduce the risk of violating the fiduciary duty of due care
Check state law
If your church is incorporated under state law, be sure to check your state nonprofit corporation law for any provisions that address the duties of officers and directors. This information should be made available to all of the church’s officers and directors.
Check the church’s governing documents and minutes
The governing documents (i.e., articles of incorporation or bylaws) of some churches contain restrictions on investments. Such restrictions may also appear in the minutes of congregational or board meetings. It is essential for board members to be familiar with these restrictions and to enforce them.
Use an investment committee
Many nonprofit organizations use an investment committee to make recommendations regarding the investment of funds. This can be an excellent way to reduce the liability of board members for poor investment decisions. Rather than make decisions themselves, the board appoints an investment committee that includes individuals with proven investment or financial expertise. Committee members may include stock brokers, CPAs, attorneys, bankers, financial planners, and business leaders. Of course, the committee’s recommendations ordinarily must be approved by the governing board, but by relying on the advice of experts the board is greatly reducing the risk of being liable for poor investment decisions. After all, they were relying on the advice of experts.
Key point. The Model Revised Nonprofit Corporation Act (quoted above) specifies that “in discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by … persons as to matters the director reasonably believes are within the person’s professional or expert competence ….” This language provides directors with considerable protection when relying on the advice of experts on an investment committee.
A church congregation or board can create an investment policy to govern investment decisions. A policy can prohibit investments in specified instruments or programs.
Avoid speculative or risky investments
If a proposal sounds “too good to be true,” it probably is. Any scheme that promises to “double your money” in a short period of time should be viewed with extreme skepticism. It is absolutely essential that such schemes not be pursued without the thorough evaluation and recommendation of persons with financial and investment expertise.
Key point. Do not rely on the “expert opinion” of persons representing the promoter of an investment scheme. Investment schemes must be reviewed by independent and objective persons having financial and investment expertise. Ideally, these persons will be members of your church, or persons within your community who have a reputation of unquestioned integrity.
Key point. Remember, you are investing donated funds. This is no time to be taking risks. Not only do officers and directors have a legal duty to exercise due care in the investment of church funds. Just as importantly, they have a moral duty to be prudent in their investment decisions. No officer or director wants to explain to church members at an annual business meeting how some of their contributions were lost due to poor investments.
Avoid investing in companies or programs in which a board member has a personal interest. The third case summarized above demonstrates the need to avoid investing in companies or programs with direct ties to a member of your board. Such investments are not always inappropriate. But they demand a higher degree of scrutiny.
Key point. A church’s investments should be reviewed at every board meeting. This ensures that all investments will be continuously monitored, and that necessary adjustments can be made.
Trustees have a higher duty
Sometimes church board members are designated as the trustees of a charitable trust. For example, a member dies leaving a large sum to the church for a specific purpose and designates the church board as the trustee of the fund. Trustees are held to an even higher degree of care in the investment of trust funds than officers or directors of a corporation.
However, the Revised Model Nonprofit Corporation Act specifies that “a director shall not be deemed to be a trustee with respect to the corporation or with respect to any property held or administered by the corporation, including without limit, property that may be subject to restrictions imposed by the donor or transfer or of such property.”
In other words, a church officer or director is not automatically deemed to be a “trustee” of church funds. officers and directors generally are held to the higher legal standard applicable to trustees only if they are designated as trustees in a legal instrument that creates a trust fund.
In conclusion, church officers and directors must take steps to inform themselves about any investment decision involving church funds. They can rely on a number of safeguards, including their own research, the recommendations of an investment committee, and common sense.
Review of related court cases
Below are several courts cases involving the personal liability of church officers, directors, and trustees.
Marwil v. Grubbs, 2004 WL 2278751 (S.D. Ind. 2004).
A federal court in Indiana ruled that the directors of a church subsidiary could be sued individually for financial losses incurred by investors in a securities scam on the basis of their breach of their fiduciary duty of care.
Shepherd of the Valley Lutheran Church v. Hope Lutheran Church, 626 N.W.2d 436 (Minn. App. 2001).
A Minnesota court ruled that a church officer violated his fiduciary duties to his church as a result of his secret efforts to remove the pastor and have the church property transferred to a new church that he had formed.
The court noted that “an officer of a nonprofit corporation owes a fiduciary duty to that corporation to act in good faith, with honesty in fact, with loyalty, in the best interests of the corporation, and with the care of an ordinary, prudent person under similar circumstances.” The officer conceded that he owed a fiduciary duty to the church, but he insisted that the evidence did not support a finding that he breached his fiduciary duty because his actions were consistent with the wishes of the church members who supported him.
The court disagreed: “As the bearer of a fiduciary duty, the law imposed on him the highest standard of integrity in his dealings with the other officers of [the church] and the entire [church] congregation, not just those who [supported him]. Therefore … as an officer of [the church] his fiduciary duty prevented him from assuming positions, and taking actions, that conflicted with the interests of [the church] and the congregation as a whole …. There is sufficient evidence in the record to establish that the officer breached his fiduciary duty to [the church].
He admitted that while he was vice president of the church he organized a faction for the purpose of forming another church to directly compete with [the original church]. Further, the formation of a new church was intended to be a method of circumventing the national church’s termination provisions governing the pastor’s services. To achieve his goals, he held secret meetings and continuously encouraged secrecy among [his supporters]. He did not inform other church offi cials and members of … his plans to form [a new church], separate from [the original church], and transfer the church property from [the original church to the new church] without compensation.”
Basich v. Board of Pensions, 540 N.W.2d 82 (Minn. App. 1995).
A Minnesota court dismissed a lawsuit brought by Lutheran pastors against a denominational pension board for allegedly breaching their fiduciary duty to participants by not investing in companies that did business in South Africa. The Evangelical Lutheran Church in America (ELCA) established a board of pensions in 1988 to manage and operate a pension fund for Lutheran pastors and lay employees
The ELCA adopted the position that the system of apartheid in South Africa was so contrary to Lutheran theology that it had to be rejected as a matter of faith. The ELCA passed a resolution to “see that none of our ELCA pension funds will be invested in companies doing business in South Africa.”
A dissenting group of Lutherans opposed the ELCA’s decision to use its assets as a political weapon and asked to withdraw their pension funds. When their request was denied they sued the board of pensions and the ELCA, claiming that both groups had violated their fiduciary duties to participants in the pension program by elevating social concerns over sound investment strategy.
A state appeals court dismissed the lawsuit on the ground that a resolution of the lawsuit would require the court to interpret religious doctrine in violation of the First Amendment’s non establishment of religion clause. The court concluded that the “ELCA enacted the [apartheid] policy in an effort to further its social and doctrinal goals …. Accordingly, any review of the Board of Pensions’ [investment policy] would entangle the court in reviewing church doctrine and policy.”
Spitzer v. Lev, 2003 WL 21649444 (N.Y. Sup. 2003).
A New York court ruled that the officers of a nonprofit organization violated their fiduciary duties and could be removed from office by the attorney general and ordered to pay damages. The state attorney general of New York sued the officers of a charity seeking to hold them personally liable and financially accounTable for amounts totaling more than $120,000 which they allegedly received in violation of their fiduciary duties.
The attorney general also sought to remove two of the officers and permanently bar them from ever serving as board members of a public charity. One of the officers freely admitted that he charged several personal expenses to the charity, but defended himself by stating, “I erroneously believed that it would be permissible for me to charge certain personal expenses to [the charity] and have them reclassified as personal expenses to be paid back to [the charity].”
The court called this allegation “startling,” and further observed, “This court is at a loss as to why anyone would think they could charge something to a not-for-profit corporation as long as they paid it back later. After all, [the charity] is a not-for-profit corporation and not a revolving credit line.”
Scheuer Family Foundation, Inc. v. 61 Associates, 582 N.Y.S.2d 662 (A.D. 1 Dept. 1992).
A New York appeals court ruled that directors of a chariTable trust could be sued for breaching their fiduciary duties. A child of the founder of the trust filed a lawsuit seeking to remove 8 of the trust’s 11 directors. He asserted that the 8 directors breached their fiduciary duties, mismanaged the trust’s investments, and negligently selected the trust’s investment advisor.
The court ruled that the 8 directors could be sued. It noted that “it is well established that, as fiduciaries, board members bear a duty of loyalty to the corporation and may not profi t improperly at the expense of their corporation.” In this case, the lawsuit alleged that the 8 directors breached their fiduciary duties by investing a substantial portion of the trust’s assets in speculative securities and in the stock of a company with direct ties to the directors.
The court concluded that the “business judgment rule” (which protects directors from any liability for their reasonable and good faith decisions) did not apply in this case, since it was not available “when the good faith or oppressive conduct of the officers and directors is in issue.”
State v. Meagher, 1997 WL 180266 (Ohio App. 1997).
An Ohio court refused to allow church members to sue board members personally for breaching their fiduciary duties by failing to oust a pastor who allegedly had engaged in financial improprieties. It observed: “Inquiry into the relationship between the trustees and the congregation in matters concerning the pastorship would require the courts to consider each party’s view of who should preach from the pulpit.
Review of such matters would further require the court to determine the issue of whether the trustees’ performance of their duties met the standards of the congregation and would therefore involve an inquiry into ecclesiastical concerns. Therefore … civil courts lack … jurisdiction to entertain such matters …. [We] hold that the lower court has no jurisdiction over the claims brought by the individual members of the congregation seeking to … hold the board liable for breach of fiduciary duty to the congregation.”