“Nonprofit” Is Not An Inherently Unique Legal Status
Organization, Structure, and Governance. In Colorado, as in many other states, a special nonprofit corporation statute offers an alternative form of organization to for–profit corporations, partnerships, limited liability companies, and trusts. C.R.S. § 7–123–101 permits a nonprofit corporation in Colorado to be organized “for any lawful purpose,” but such a corporation may not pay a dividend or distribute any income or profit to its members, directors, or officers except for certain distributions upon liquidation. C.R.S. § 7–133–101.
Applicability of Other Laws. Otherwise, nonprofit corporation are, for the most part, subject to exactly the same body of laws under which all other organizations must operate — tort, contract, tax, bankruptcy, labor, antitrust, securities, and other laws.
Legal Status
A nonprofit corporation is a legal entity with statutory power to “sue and be sued, complain, and defend in its corporate name.” C.R.S. § 7–123–102(1)(b).
Its liability is generally separate from that of its members, directors, officers, and employees, and “[t]he directors, officers, employees, and members of the corporation shall not, as such be liable on its obligations.” C.R.S. § 7–126–103.
Authority of Corporate Officers
Montoya v. Grease Monkey Holding Corporation, 883 P.2d 486 (Colo. App. 1994), aff’d, 904 P.2d 468 (Colo. 1995), a case involving a for–profit corporation, illustrates one possibly extreme view of the scope of authority of corporate officers. The Chairman of the Board, President, and Chief Operating Officer of Grease Monkey secured a series of “loans” from Mr. Montoya based on representations that the moneys would be considered an investment in the Grease Monkey franchise system. In fact, the checks that the plaintiff wrote were payable directly to the Chairman, who had indicated that Grease Monkey was a new corporation and did not yet have its own bank account; the Chairman issued his personal promissory notes to reflect the loans. None of the loan proceeds were ever delivered to the corporation, and the Chairman subsequently failed to repay them. The trial court awarded a judgment against Grease Monkey and in Mr. Montoya’s favor on a theory of fraud and misrepresentation.
The Colorado Court of Appeals affirmed the judgment based upon the following theory of agency:
A principal who puts a servant or other agent in a position which enables the agent, while apparently acting within his authority, to commit a fraud upon third persons is liable to such third persons for the fraud.
Restatement (Second) of Agency, § 261. This principle applies, according to the Court of Appeals, “even though the principal had no knowledge of the fraud, did not authorize the fraud, and did not receive any benefit from the transaction.”
In this case, the jury found that the corporation’s Chairman was “doing what is necessarily incidental to the work that has been assigned to him or which is customarily within the business in which the employee is engaged.”
On the other hand, there are certainly situations where a corporate officer cannot reasonably be considered to have authority to make commitments binding upon the corporation. SeeLee v. Jenkins Bros., 156 F. Supp. 858 (D. Conn. 1957), aff’d 268 F.2d 357 (2d Cir. 1959), cert. denied, 361 U.S. 913 (1959) (the scope of a board president’s authority does not extend to promising pension benefits to employees).
Harmful Acts of Employees
Moses v. Diocese of Colorado, 863 P.2d 310 (Colo. 1994). In a highly publicized case, Mary Moses Tenantry brought suit against the Episcopal Diocese of Colorado and its Bishop seeking damages arising from an affair she had with a priest. Evidence disclosed that the priest’s personnel file contained reports of his having had problems of depression, low self–esteem, and “sexual identification ambiguity,” but that church officials took no action to avoid placing the priest in a position of counseling vulnerable individuals. The jury also concluded that church officials, upon having been informed of the priest’s conduct, took no disciplinary steps against him, but instead attempted to prevent Ms. Tenantry from pursuing any claim.
Vicarious Liability for Acts of Employees. On appeal, the Colorado Supreme Court overturned the jury’s award of a verdict under a common theory of agency law, that of vicarious liability. This principle states that an employer is personally liable for acts committed by its agents or employees in the course of their employment. Connes v. Molalla Transport System, Inc., 831 P.2d 1316 (Colo. 1992). Under the circumstances, the Court concluded that the priest’s conduct could in no way be considered to have occurred within the scope of his employment.
Negligent Hiring and Supervision. The Court held, however, that the church was negligent in its hiring and supervision of the priest. “An employer may be liable for harm to others for negligently employing an improper person for a task which may involve a risk to others.” Restatement (Second) of Agency § 213(b) (1958). As stated in Comment d to the Restatement, “[t]he principal may be negligent because he has reason to know that the servant or other agent, because of his qualities, is likely to harm others in view of the work or instrumentalities entrusted to him. If the dangerous quality of the agent causes harm, the principal may be liable under the rule that one initiating conduct having undue tendency to cause harm is liable therefor.”
Other publicized cases of vicarious liability or negligent hiring include:
A local Goodwill Industries organization, paid nearly $5 million to the parents of a teenage girl murdered by a parolee it employed. Taylor, Goodwill Must Pay $5M in Murder by Parolee–Employee, Nat’l L.J., June 1987, at 22.
A Virginia chapter of the Boy Scouts of America paid $45,000 to a boy molested by a scout master. Infant C. v. Boy Scouts of America, 391 S.E.2d 322 (Va. 1990).
The YMCA paid a 5–year old girl who nearly drowned while participating in a youth swimming program a lump–sum settlement of $831,000 in addition to monthly payments for life. Rohn, YMCA, Pool Victim Settle, Wash. Post, May 17, 1978, at A4.
Defamatory Employment References. Given the potential liabilities associated with hiring an employee who subsequently harms others, it is unfortunate that former employers have tended to become extremely circumspect about providing any information concerning a former employee’s job performance to any third party, fearing a libel or slander claim. Often, a former employer’s response to any request for a job reference may be limited to confirmation that the employee was in fact employed and the dates of employment.
C.R.S. § 8–2–114(1), however, seeks to provide some comfort in this area and states as follows:
employer who provides information about a current or former employee's job history or job performance to a prospective employer of the current or former employee upon request of the prospective employer or the current or former employee is immune from civil liability and is not liable in civil damages for the disclosure or any consequences of the disclosure. This immunity shall not apply when such employee shows by a preponderance of the evidence both of the following:
The information disclosed by the current or former employer was false; and
The employer providing the information knew or reasonably should have known that the information was false.
For these purposes, “job performance” means:
The suitability of the employee for reemployment;
The employee's work-related skills, abilities, and habits as they may relate to suitability for future employment; and
In the case of a former employee, the reason for the employee's separation.
In addition, any employer that provides written information to a prospective employer about a current or a former employee must send, upon the request of the current or former employee, a copy of the information provided to the last-known address of the person who is the subject of the reference. Any person who is the subject of such a reference may obtain a copy of the reference information by appearing at the employer's or former employer's place of business during normal business hours.
Doctrine of Charitable Immunity
On approximately six occasions over the past 80 years or so, the Colorado Supreme Court has held that what was historically known as the doctrine of charitable immunity remains an effective rule of law in Colorado. See, e.g., Hemenway v. Presbyterian Hospital Ass’n of Colo., 419 P.2d 312, 161 Colo. 42 (1966); Michard v. Myron Stratton Home, 355 P.2d 1078 (Colo. 1960) (limiting the doctrine to assets held in trust); St. Luke’s Hospital Ass’n v. Long, 240 P.2d 917, 125 Colo. 25 (1952); St. Mary’s Academy of Sisters of Loretto of City of Denver v. Solomon, 238 P.2d 22 (Colo. 1925).
This doctrine is premised on the questionable assumption that certain nonprofit organizations hold their assets in a sort of charitable trust for the benefit of the public generally and holds that no individual ought to be permitted to recover a judgment against such a nonprofit, charitable organization, since to do so would deplete assets otherwise held for the benefit of the public in its entirety. See Lipson, Charitable Immunity: The Plague of Modern Tort Concepts, 7 Clev.–Marshall L. Rev. 483 (1958).
The doctrine originated from dicta in two 1846 English cases that were later reversed by the House of Lords in 1886. Nonetheless, the doctrine at one point was widely adopted in the United States, although it has since been repealed in the majority of American jurisdictions. The Colorado Supreme Court has significantly limited its scope and is likely to eliminate the doctrine in Colorado altogether when the proper opportunity arises. See Michard v. Myron Stratton Home, 355 P.2d 1078 (Colo. 1960) (calling the doctrine “highly restricted”); O’Connor v. Boulder Colorado Sanitarium Ass’n, 96 P.2d 835, 105 Colo. 259 (1940) (a “qualified immunity rule”); Hemenway v. Presbyterian Hospital Ass’n of Colo., 419 P.2d 312, 161 Colo. 42 (1966) (issued by a divided Colorado Supreme Court, with a dissent advocating for its prospective abolition).
In any event, the doctrine has been modified and codified to some extent in C.R.S. § 7–123–105, which provides that “[a]ny other provision of law to the contrary notwithstanding, any civil action permitted under the laws of this state may be brought against any nonprofit corporation, and the assets of any nonprofit corporation which would, but for articles 121 to 137 of this title, be immune from levy and execution on any judgment shall nonetheless be subject to levy and execution to the extent that such nonprofit corporation would be reimbursed by proceeds of liability insurance carried by it were judgment levied and executed against its assets.” SeeO’Connor v. Boulder Colorado Sanitarium Ass’n, 96 P.2d 835, 105 Colo. 259 (1940).
The doctrine of charitable immunity is also probably not applicable to nonprofit corporations that are not specifically charitable in nature, such as trade associations, social clubs, and labor unions.
Good Samaritan Immunity
Westernaires, Inc. is a nonprofit corporation that teaches and promotes horseback riding and other equestrian activities for young persons. Paula Jo Jones was a volunteer for the Westernaires who severely injured her leg when she stepped into a trench on the defendant’s property while trying to guide an out–of–control wagon towards a haystack. In a surprising but confusing opinion, in Jones V. Westernaires, Inc., 876 P.2d 50 (Colo. App. 1993), the Colorado Court of Appeals held that the Westernaires could not, as a matter of law, be liable for Mrs. Jones’s injuries.
The Colorado legislature originally enacted C.R.S. § 13–21–116 in 1986 for the purpose of encouraging “the provision of services or assistance by persons on a voluntary basis to enhance the public safety rather than to allow judicial decisions to establish precedents which discourage such services or assistance to the detriment of public safety.” As originally enacted, C.R.S. § 13–21–116 was apparently intended to extend immunity to good Samaritans by specifying that they would not be deemed to have assumed any duty of care in the course of rendering assistance on a voluntary basis.
In 1987, however, the legislature added a new subsection 2.5(a) to C.R.S. § 13–21–116, which stated as follows:
No person who performs a service or an act of assistance, without compensation, as a leader, assistant, teacher, coach, or trainer for any program, organization, association, service group, educational, social, or recreational group, or nonprofit corporation serving young persons or providing sporting programs or activities for young persons shall be held liable for actions taken or omissions made in the performance of his duties except for willful and wanton acts or omissions; except that such immunity from liability shall not extend to protect such person from liability for acts or omissions which harm third persons.
At the same time, the legislature changed the title of C.R.S. § 13–21–116 by adding “immunity for volunteers assisting organizations for young persons.”
When it was originally enacted in 1986, C.R.S. § 13–21–116(4) defined the term “person” as including an individual, corporation, partnership, or association. The 1987 amendment did not change this definition, nor did it modify the declaration of legislative intent.
As a result, and since the Westernaires had always been fully staffed by volunteers, the Court of Appeals concluded that the statute provides immunity for a corporation, like the Westernaires, that provides sporting programs or activities for young persons.
It is important to note that the Westernaires case may be confined to its own peculiar facts and that the statute does not extent its immunity to liability for injuries to third parties.
Liabilities of Corporate Directors and Officers
General Considerations.
For a variety of reasons, including the possible lingering validity of the doctrine of charitable immunity, the relative worth of nonprofit corporations and their boards of directors, and so on, plaintiffs asserting claims against a nonprofit corporation are not likely to confine their complaints to the corporation alone and can be expected to search for theories that would require directors and officers personally to appear in a lawsuit. Thus, the prospect of personal liability to outsiders — such as persons injured in “slip and fall” accidents or third parties seeking damages under a contract the corporation has failed to perform — presents (although somewhat unjustifiably) the greatest source of anxiety to the management of nonprofit corporations.
At the same time, however, directors and officers should keep in mind that their primary duty, and what may in fact be the greatest source of their personal liability, is to the corporation itself.
Directors and officers of a nonprofit corporation, acting in their capacity as such, are required to observe certain duties to the corporation, to its members, and possibly to the general public and can in certain instances be held personally liable for failing to perform those duties.
In addition, directors and officers can be held accountable for conduct that they have engaged in other than in their official capacity, for example, for personal negligence or professional misconduct, slander, fraud, and the like.
In any event, an officer or director can be found liable, either to the corporation or to a third party, only if that officer or director held some duty to the plaintiff, and the officer or director has breached that duty. Accordingly, before turning to a discussion of the various legal defenses and immunities that may be available to the directors and officers of Colorado nonprofit corporations in general, it may be helpful to consider the types of duties those individuals are subject to and the nature of the liabilities they may encounter.
Duties Owed to the Corporation
Analogizing to principles of charitable trusts, courts have historically considered that directors of a nonprofit corporation serve in a fiduciary capacity and thus held them to be subject to the standards of conduct applicable to trustees.
Applicability of Business Standards. More recent decisions have tended to respect the differences between trusts and corporations and impose standards of conduct on the directors of nonprofit corporations similar to those observed by the corporate business community generally. Stern v. Lucy Webb Hayes National Training School for Deaconesses, 381 F. Supp. 1003 (D.D.C. 1974); City of Paterson v. Paterson General Hospital, 97 N.J Super. 514, 235 A.2d 487 (Ch. Div. 1967).
These courts have generally applied a “business judgment rule” to the conduct of directors, that states that directors who have reasonably exercised an honest unbiased judgment in the management of a corporation’s affairs, on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the corporation, will not be held liable, even if that judgment later turns out to be wrong. Beard v. Achenbach Memorial Hospital, 170 F.2d 859 (10th Cir. 1948).
Duty of Care
The Colorado Revised Nonprofit Corporation Act, C.R.S. § 7–128–401, has now codified the duty of care in the following manner:
(1) Each director shall discharge the director's duties as a director, including the director's duties as a member of a committee of the board, and each officer with discretionary authority shall discharge the officer's duties under that authority:
(a) In good faith;
(b) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
(c) In a manner the director or officer reasonably believes to be in the best interests of the nonprofit corporation.
(2) In discharging duties, a director or officer is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by:
(a) One or more officers or employees of the nonprofit corporation whom the director or officer reasonably believes to be reliable and competent in the matters presented;
(b) Legal counsel, a public accountant, or another person as to matters the director or officer reasonably believes are within such person's professional or expert competence;
(c) Religious authorities or ministers, priests, rabbis, or other persons whose position or duties in the nonprofit corporation, or in a religious organization with which the nonprofit corporation is affiliated, the director or officer believes justify reliance and confidence and who the director or officer believes to be reliable and competent in the matters presented; or
(d) In the case of a director, a committee of the board of directors of which the director is not a member if the director reasonably believes the committee merits confidence.
(3) A director or officer is not acting in good faith if the director or officer has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (2) of this section unwarranted.
(4) A director or officer is not liable as such to the nonprofit corporation or its members for any action taken or omitted to be taken as a director or officer, as the case may be, if, in connection with such action or omission, the director or officer performed the duties of the position in compliance with this section.
(5) A director, regardless of title, shall not be deemed to be a trustee with respect to the nonprofit corporation or with respect to any property held or administered by the nonprofit corporation including, without limitation, property that may be subject to restrictions imposed by the donor or transferor of such property.
The Act requires directors to exercise the “care that an ordinarily prudent person in a like position would exercise under similar circumstances” and is intended to permit directors to exercise their judgment with an appropriate regard to the nature, operations, finances, and objectives of the organization.
The Act’s reference to an “ordinarily prudent person” is intended to clarify that directors are not expected to guarantee the success of corporate operations, but are permitted balance potential risks and rewards, to innovate and assume informed risks.
At the same time, the duty of care presumes that the directors will —
remain attentive to corporate affairs
attend meetings on a reasonably consistent basis
acquaint themselves with material presented to them for review at meetings
inquire into the relevant surrounding circumstances when that information appears insufficient or unclear.
That directors must act as would others “in a like position” implies that directors of nonprofit corporations are typically expected to carry out different responsibilities from their counterparts in for–profit organizations. The organization itself may have different goals and objectives, and its financial resources may make it reasonable to take varying risks or to adopt innovative programs. Also, although directors may be entitled to expect that the courts will recognize that they typically serve without compensation and have no economic interest in the corporation, that fact alone does not authorize them to ignore their responsibilities.
Nonprofit corporations often elect members to their boards whose primary qualification is an ability to raise money or in recognition of substantial financial support. While directors of this nature may not be required to exercise any special expertise or skills, they cannot simply act as figureheads and ignore their basic board responsibilities. Conversely, directors who are also paid employees of the corporation may be expected to exercise a more active and knowledgeable role in making decisions.
Finally, directors are expected to carry on their duties “in good faith.” Fundamentally a subjective standard that implies an inquiry into a director’s state of mind, the courts may examine all the relevant facts and circumstances to determine whether the director acted honestly and faithfully, or whether there is some indication that a director intended to take advantage of the corporation.
Examples.
Barbara Bush and Elizabeth Dole were among the members of the board of directors of the Community Foundation of Greater Washington and illustrate the caliber of its board. According to its tax returns, the Foundation’s senior staff member incurred approximately $250,000 in travel and meeting expenses on the Foundation’s behalf at a time when donations were declining. None of the Foundation’s board members were aware of these excessive travel figures until they were revealed by the press. As one board member stated, “when you meet maybe twice a year, you don’t do a lot of micromanagement.” Quoted in Shenk, “Board Stiffs: United Way of America’s Board of Directors,” Washington Monthly, May 1994, at 10.
In Stern v. Lucy Webb Hayes National Training School for Deaconesses, 381 F. Supp. 1003 (D.D.C. 1974), the court found that the directors had breached their duty of care by routinely accepting the recommendation of the corporation’s treasurer that substantial portions of the hospital’s assets be invested in non–interest–bearing accounts and where the hospital’s investments committee had not met for 11 years.
While a director may defend an action asserting breach of the director’s duty of care by claiming reliance on information furnished by officers and employees, board committees, legal counsel, and public accountants, that reliance must be reasonable and may subject the director to a duty to investigate further. While the board of directors of Stanford University relied on an audit of its government contract grants by the federal Defense Contract Audit Agency, disclosure in the press that the University had in fact inappropriately charged indirect costs to the government resulted in substantial embarrassment. One director weakly defended the board’s oversight by noting that “all these improper expenses add up to a total of maybe one million or two ... that’s not a lot of money ... there is no way to smell something like that.” Adams, Denby and Zipser, “A Nonprofit Director’s Roadmap for Survival,” Trusts and Estates, March 1996, at 48.
In United States v. Mount Vernon Mortgage Corp., 128 F.2d 629 (D.D.C. 1954), the directors of the National Home Library Foundation sold the sole asset of the foundation for what the court described as “shockingly inadequate” consideration, without having conducted any investigation into its true value or attempting to locate alternate purchasers. The court replaced the board of directors.
In Gilbert v. McLeod Infirmary, 219 S.C. 174, 64 S.E.2d 524 (1951), a South Carolina hospital sold its facility to one if its directors with “unseemly haste” two days after such a sale had been proposed, without soliciting any other offers, and without any effort to determine whether the offered price was the best available, while comparable properties were being sold for 140 percent of the price that the interested director had proposed.
Duty of Loyalty — Conflicts of Interest
Traditionally, the level of loyalty which directors of nonprofit corporations were expected to observe was that applicable to trustees. In the law of trusts, a trustee is simply not permitted to deal with trust property for his own account without the consent of the beneficiaries, and any transaction violating this prohibition could have been voided by the beneficiaries. Even with the consent of the beneficiaries, transactions between the trustee and trust might have been voidable if full disclosure were lacking or the trustee used his influence to induce the consent.
The duty of loyalty is essentially a duty to avoid conflicts of interest, any use of a director’s position or information about the organization or its affairs to gain a personal advantage. This duty recognizes that a person’s ability to “weigh the best interests of an institution in a fair and rational manner may be obscured by the prospect of personal gain.” Adams, Denby and Zipser, “A Nonprofit Director’s Roadmap for Survival,” Trusts and Estates, March 1996, at 50. The business judgment rule may not be available as a defense to directors who engage in a transaction involving a conflicts of interest. S.H. and Helen R. Sheuer Family Foundation v. 61 Associates, 179 A.D.2d 65, 582 N.Y.S.2d 662 (N.Y. App. 1992).
The Colorado Revised Nonprofit Corporation Act, C.R.S. § 7–128–501, states that transactions involving a conflicts of interest with respect to a nonprofit corporation may be valid if either [a] the interested director makes known all material facts regarding his relationship and the proposed transaction and the transaction is ratified by a majority of the remaining disinterested directors or, under certain circumstances, by the members, or [b] the transaction is in fact fair to the corporation.
Loans to Directors. C.R.S. § 7–128–501 specifically prohibits one type of transaction between a nonprofit corporation and its directors. Not only can a nonprofit corporation not extend loans to its officers and directors, but any officer or director who has approved or participated in the making of any such loan is personally liable to the corporation for the full amount of the loan until its repayment.
Sample Conflicts of Interest Policy. A preferable policy is to establish a formal policy that avoids even the appearance of impropriety and which adheres to the most demanding standards. The key elements of such a policy include:
Disclosure: Individual directors should be encouraged to remain alert to the possibility of conflicts of interest and with candor and in good faith to make full disclosure of all the relevant facts and circumstances.
Withdrawal and Abstention: Once a potential conflict of interest appears, the interested director should withdraw from any discussion of the matter and abstain from voting on the issue.
Due Deliberation by Disinterested Directors: The matter should be fully considered by a quorum of disinterested directors, who should be governed by the primary objective of advancing the corporation’s best interests.
Documentation: The minutes of the meetings of the board on the issue should reflect full compliance with all aspects of the conflicts of interest policy, including all considerations that demonstrate that the transaction is the most advantageous that the corporation might obtain.
Intermediate Sanctions. The Internal Revenue Code’s “intermediate sanctions,” which are codified in Section 4958, permit the Internal Revenue Service to regulate transactions that essentially represent private inurement short of revoking an organization’s tax–exempt status.
The new law imposes a tax on each disqualified person receiving an excess benefit equal to 25 percent of any excess amount. An additional 10 percent tax (up to a maximum of $10,000) can be imposed on each organization manager who knew that the transaction was an excess benefit transaction.
For these purposes, “disqualified persons” include any person who is in a position to exercise substantial influence over an organization’s affairs., together with any person who occupied such a position within the previous five years, as well as their family members and 35 percent or more controlled entities. An organization manager is an officer, director, or trustee, or any person having similar responsibilities.
The tax is imposed whenever an organization provides, directly or indirectly, an economic benefit to a disqualified person if the value of the economic benefit exceeds the value of the consideration (including the performance of services) that the organization received for providing the benefit.
If the excess benefit transaction is not timely corrected (presumably by repayment of the excess benefits), a second tax equal to 200 percent of the excess benefit will be imposed on the disqualified person.
The reasonableness of compensation is to be tested under existing law standards, but that the parties to a transaction are entitled to rely on a rebuttable presumption of reasonableness with respect to compensation if such arrangement was approved by a board of directors or trustees (or committee thereof) that:
was composed entirely of individuals unrelated to and not subject to the control of the disqualified person(s) involved in the arrangement,
obtained and relied upon appropriate data as to comparability (e.g., compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the location of the organization, including the availability of similar specialties in the geographic area; independent compensation surveys by nationally recognized independent firms; or actual written offers from similar institutions competing for the services of the disqualified person), and
adequately documented the basis for its determination (e.g., the record includes an evaluation of the individual whose compensation was being established and the basis for determining that the individual's compensation was reasonable in light of that evaluation and data).
If these three criteria are satisfied, penalty excise taxes could be imposed only if the Internal Revenue Service develops sufficient contrary evidence to rebut the probative value of the evidence put forth by the parties to the transaction (e.g., the Service could establish that the compensation data relied upon by the parties was not for functionally comparable positions or that the disqualified person, in fact, did not substantially perform the responsibilities of such position). A similar rebuttable presumption would arise with respect to the reasonableness of the valuation of property sold or otherwise transferred (or purchased) by an organization to (or from) a disqualified person if the sale or transfer (or purchase) is approved by an independent board that uses appropriate comparability data and adequately documents its determination.
For purposes of the new intermediate sanctions, an exempt organization includes any organization described in Sections 501(c)(3) or (4), or that was so described within the previous five years.
One very significant trap in the intermediate sanctions legislation is the statutory statement that “an economic benefit shall not be treated as consideration for the performance of services unless such organization clearly indicated its intent to so treat such benefit.”
The legislative history indicates that the intention to treat the benefit as compensatory must be contemporaneous with the grant of the benefit.
Since any economic benefit that is not supported by consideration will constitute an excess benefit, and since an economic benefit that is not contemporaneously treated as compensation will not be considered supported by consideration, all benefits given to a disqualified person that are not properly reported (on a Form W–2, 1099, and the like) will become taxable, even if the benefits are granted only after following the appropriate procedures to ensure reasonableness and are, when aggregated with all other benefits, reasonable in fact. Thus, there is a significant incentive to identify all benefits that are taxable and report them appropriately.
Enforcement of Directors’ Duties to the Corporation
It is one thing for the statutes to define the duties of care and loyalty owed by directors to their corporations, but another to enforce them. The universe of potential plaintiffs having standing to assert that a director has breached one of his or her duties is generally quite small.
The committee of the Colorado Bar Association that assisted in the process of drafting the Colorado Revised Nonprofit Corporation Act consciously and emphatically chose to eliminate from the statute any authority of the State Attorney General to regulate, supervise, or monitor the affairs of nonprofit corporations. In Colorado, the Attorney General’s sole authority relates to —
the enforcement of charitable trusts: “The general assembly hereby recognizes and reaffirms that the attorney general has all powers conferred by statute, and by common law in accordance with section 2-4-211, C.R.S., regarding all trusts established for charitable, educational, religious, or benevolent purposes.” C.R.S. § 24-31-101(5), and
the approval of the sale and merger of health care institutions. C.R.S. § 6–19–203.
Derivative Actions. One of the Colorado Revised Nonprofit Corporation Act’s more significant and controversial changes is to authorize derivative actions. Long a familiar mechanism for bringing a lawsuit in the for–profit corporate world, a derivative suit is a suit to enforce a right of the corporation against its officers or directors. Without the possibility of a derivative action, a corporation might have no remedy against those of its directors and officers who have misbehaved, since it would, under those circumstances, be the miscreants who have the responsibility for managing the corporation.
C.R.S. § 7–126–401 allows any director or any voting members having five percent or more of the voting power (all of whom must be voting members or directors at the time of bringing the lawsuit) to bring a suit in the right of the nonprofit corporation to secure a judgment in its favor.
In the case of derivative suits brought by the voting members, the court may require the plaintiffs to provide security for costs and expenses that the corporation may incur, but not including attorneys’ fees.
The legislature added a prefatory phrase to C.R.S. § 7–126–401, indicating that that section would apply “[w]ithout affecting the right of a member or director to bring a proceeding against a nonprofit corporation or its officers or directors.” It is unclear what that prefatory phrase is intended to mean.
Liabilities to Third Parties
While the nature of the duties owed by directors and officers to third parties would appear to be as varied as the imaginations of plaintiffs’ lawyers, those duties are not unlimited.
Nonetheless, the extraordinary variety of circumstances when personal liability could conceivably be claimed to attach to the actions of directors and officers, acting in either their official or unofficial capacities, is somewhat staggering. While it is certainly beyond the scope of this outline to consider the merits of all possible claims of this nature, a realistic appreciation of their diversity provides important background to an understanding of the legal defenses and immunities available to officers and directors.
Tortious or Negligent Conduct. Included among these potential liabilities is the whole spectrum of tortious conduct:
Aggrieved employees may seek damages for wrongful termination, violations of their civil rights, or employment law violations.
An injured hospital patient may argue that the board failed to supervise its medical staff and issued credentials to an incompetent physician.
The parents of an abused student may complain that the school board should have more thoroughly investigated its teachers’ backgrounds.
A donor may demand damages for a contribution fraudulently solicited.
A disinherited family member might sue the charitable beneficiary of an estate or trust on the grounds that its management exercised undue influence or fraudulently obtained a charitable bequest.
A member of a boys’ baseball league brought suit against the coach for injuries sustained. Byrne v. Fords–Clara Barton Boys Baseball League, 564 A.2d 1222 (N.J. Super. App. Div. 1989).
The parents of a young girl who drowned in a swimming pool brought suit against the members of the board of directors of a condominium association. Robinson v. LaCasa Grande Condominium Ass’n, 562 N.E.2d 678 (Ill. App. 1990). See generally Weber, A Thousand Points of Fright?, Ins. Rev., Feb. 1991, at 40.
100 Percent Responsible Person Penalty. Section 6672 of the Internal Revenue Code authorizes the Internal Revenue Service to collect the so–called “trust fund” payroll taxes from any person responsible for their collection and payment who willfully fails to do so. The Internal Revenue Service utilizes the penalty as a collection device, which means that it typically tries to assert the penalty against one or more of the potentially responsible persons with the most liquid assets, regardless of the relative level of that person’s responsibility. It is unclear whether a responsible person against whom the penalty is asserted has a right under state law to seek contribution or reimbursement from other, more responsible parties. See generally Walker, The Section 6672 100% Penalty: How to Avoid Going Down with the Ship, 46 The Tax Lawyer 801 (1993).
The problem becomes even more acute in light of the Internal Revenue Service’s extreme bias in favor of classifying workers as employees, in contrast to independent contractors.
If the Service is successful in such a reclassification, the employer may not receive any automatic credit for any self–employment taxes paid by the so–called independent contractor.
The Taxpayer Bill of Rights 2, effective as of July 30, 1996, enacted a new Section 6672(e), as follows:
EXCEPTION FOR VOLUNTARY BOARD MEMBERS OF TAX-EXEMPT ORGANIZATIONS. -- No penalty shall be imposed by subsection (a) on any unpaid, volunteer member of any board of trustees or directors of an organization exempt from tax under subtitle A if such member --
(1) is solely serving in an honorary capacity,
(2) does not participate in the day-to-day or financial operations of the organization, and
(3) does not have actual knowledge of the failure on which such penalty is imposed.
preceding sentence shall not apply if it results in no person being liable for the penalty imposed by subsection (a).
A similar provision had apparently been buried in the Internal Revenue Manual for several years.
The Internal Revenue Service is required to take reasonable steps to inform the public about the scope of protection which this new legislation provides.
Unfortunately, there are a number of ambiguities in the statute, particularly relating to the use of the two different terms “voluntary” and “honorary.”
Colorado Wage Statute. C.R.S. § 8–4–101 sets forth an employer’s responsibilities regarding an employee’s final paycheck and has been interpreted as imposing a surprising liability on corporate officers.
In cases where the employer “interrupts” the employer–employee relationship, such as by firing or laying off an employee, all compensation earned and unpaid at the time of discharge is due and payable immediately. When an employee voluntarily quits or resigns, wages are due and payable on the next regular payday. According to the Colorado Division of Labor, an employer who accepts an employee’s notice of resignation but does not permit the employee to continue working throughout any contractual notice period must deliver the final paycheck immediately.
Wages subject to the Wage Statute include all wages earned, including vacation pay, but not any deferred compensation that is not yet in pay status, and the amounts to be delivered to the employee may be offset by all “lawful charges and indebtedness,” including payroll tax deductions, garnishments, deductions for loans, advances, employee theft, and certain other items.
An employer that fails to pay wages in accordance with the statute following the employee’s written demand within 60 days from separating from service and without good legal justification is liable to the employee, in addition to the amount of compensation legally proven to be due, for a penalty equal to 50 percent of such compensation or ten days wages, whichever is greater. The employee is entitled to recover attorneys’ fees in any action to enforce the collection of wages. Finally, there are criminal penalties (maximum fine of $300 and 30 days in jail) for willfully failing to pay wages in accordance with the statute.
A significant problem is that C.R.S. § 8–4–101(6) defines the term “employer” as including every person, firm, partnership, association, corporation ... and any agent or officer thereof.” In Cusimano v. Metro Auto, Inc., 860 P.2d 532 (Colo. App. 1992), the Colorado Court of Appeals held that this definition “clearly discloses an intent to impose personal liability for wages on corporate officers” and that it “contains no express requirements for liability beyond status as an officer.” In other words, the Colorado Wage Statute “imposes personal liability on at least high ranking corporate officers based solely on their status as officers.”
Piercing the Corporate Veil. Although primarily a remedy that courts have allowed in actions by creditors against for–profit corporations and their shareholders, under certain circumstances, outsiders will be permitted to ignore the separate legal status of a corporation and to pursue their claims against its management, owners, and other insiders.
One Colorado court has articulated the standards for applying the doctrine as follows:
In order to ignore a corporate entity, through the application of the alter ego doctrine, it must be shown that the stockholders’ disregard of the corporate entity made it a mere instrumentality for the transaction of their own affairs; that there is such a unity of interest and ownership that the separate personalities of the corporation and the owners no longer exist and that to adhere to the doctrine of corporate entity would promote injustice or fraud.
In this particular case, Willey v. Mayer, 876 P.2d 1260 (Colo. 1994), the sole shareholder and his wife transferred money between the corporation’s and their personal accounts indiscriminately, undertook business transactions on both an individual basis and on behalf of the corporation, and failed to maintain any corporate minutes, resolutions, stock books, or bank records with respect to the corporation.
Incidentally, almost exactly the same standard applies for purposes of treating affiliated corporations as one under the federal income tax laws:
For federal income tax purposes, a parent corporation and its subsidiary are separate taxable entities so long as the purposes for which the subsidiary is incorporated are the equivalent of business activities or the subsidiary subsequently carries on business activities. Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438 (1943); Britt v. United States, 341 F.2d 227 234 (5th Cir. 1970). That is, where a corporation is organized with the bona fide intention that it will have some real and substantial business function, its existence may not generally be disregarded for tax purposes. Britt, 431 F.2d at 234. However, where the parent corporation so controls the affairs of the subsidiary that it is merely an instrumentality of the parent, the corporate entity of the subsidiary may be disregarded. Krivo Industrial Supply Co. v. National Distillers and Chemical Corp., 438 F.2d 1098, 1101 (5th Cir. 1973); 1 W. Fletcher, Cyclopedia of the Law of Private Corporations § 43.10 (Perm. Ed. 1983).
General Counsel Memorandum 39326 (August 31, 1984).
Personal Liability for Bounced Corporate Checks. Mountain States Commercial Collections v. 99¢ Liquidators, Inc., 940 P.2d 934 (Colo. App. 1996), involved a corporation that paid for goods delivered to it with checks that were drawn on the corporate account, that were signed by a corporate officer, and that were returned for insufficient funds. The court found no evidence of fraud or other factors that would have justified piercing the corporate veil and held that the corporate officer could not be found individually liable for the corporate debt, since the checks clearly disclosed her agency capacity. Nonetheless, in a decision that begs for reversal, the Colorado Court of Appeals did hold the officer personally liable for three times the face amount of the check under C.R.S. § 13–21–109, which states that “[a]ny person who ... makes any payment ... by means of making any check ... which is not paid upon its presentment is liable to the holder of such check ... for three times the amount of the check but not less than one hundred dollars.”
Citing the usual litany of rules of statutory construction (“give effect to the intent of the General Assembly,” “statute must be read and construed as a whole,” and “[i]n cases of ambiguity, a court may also be guided by the consequences of a particular transaction”), the court noted that in C.R.S. § 4–3–402 the legislature clearly dealt with the liability of persons signing checks in a representative capacity, but that it did not do so in the treble damages statute upon which it based its decision. Thus, the court reasoned, the “person” physically signing the check is liable under the statue, even though that person is unambiguously acting as an agent for a disclosed principal.
The irony of the court’s attempt to distinguish the UCC is that the treble damages statute is full of terms borrowed directly from the law of negotiable instruments, such as the “holder” of the check, “presentment,” and “notice of nonpayment.”
Even more significant is that C.R.S. § 13–21–109(2)(b), which sets forth certain circumstances in which the treble damages penalty of C.R.S. § 13–21–109(2)(a) will not apply, begins with the language “[t]he person, also referred to in this section as the ‘maker’, shall not be liable in accordance with the provisions of paragraph (a) of this subsection (2) if....” Thus, under the court’s logic, a “maker” for purposes of the Uniform Commercial Code (which does not include authorized and disclosed agents) is different from a “maker” under the treble damages law.
Statutory Limitations on Liability
Colorado Volunteer Service Act
Legislative Findings (C.R.S. § 13–21–115.5(2))
(a) The willingness of volunteers to offer their services has been increasingly deterred by a perception that they put personal assets at risk in the event of tort actions seeking damages arising from their activities as volunteers;
(b) The contributions of programs, activities, and services to communities is diminished and worthwhile programs, activities, and services are deterred by the unwillingness of volunteers to serve as volunteers of nonprofit public and private organizations;
(c) It is in the public interest to strike a balance between the right of a person to seek redress for injury and the right of an individual to freely give time and energy without compensation as a volunteer in service to the community without fear of personal liability for acts undertaken in good faith absent willful and wanton conduct on the part of the volunteer; and
(d) The provisions of this section are intended to encourage volunteers to contribute their services for the good of their communities and at the same time provide a reasonable basis for redress of claims which may arise relating to those services.
C.R.S. § 13–21–115.5(4) states as follows:
Any volunteer shall be immune from civil liability in any action on the basis of any act or omission of a volunteer resulting in damage or injury if:
(I) The volunteer was acting in good faith and within the scope of such volunteer’s official functions and duties for a nonprofit organization, a nonprofit corporation, an a hospital; and
(II) The damage or injury was not caused by willful and wanton misconduct by such volunteer.
For purposes of this statute, “nonprofit corporations” and “nonprofit organizations” are limited to those exempt from taxation under Section 501(a) or described in Section 501(c) of the Internal Revenue Code. The term also includes a homeowners’ association that is described in Section 528 of the Code.
A “volunteer” is any person performing services for a nonprofit organization, a nonprofit corporation, or a hospital without compensation other than reimbursement for actual expenses incurred. The term excludes a director, officer, or trustee protected from civil liability under C.R.S. §§ 13–21–115.7 or 116, as well as licensed physicians performing services or providing medical care or treatment as a volunteer for a nonprofit organization or hospital.
Acts Within Scope of Official Duties
Effective April 23, 1992, C.R.S. § 13–21–115.7(2) is intended to reduce the exposure of the members of boards of directors, officers, and other volunteers associated with nonprofit organizations to liability from civil lawsuits. That section provides in part as follows:
In addition to the provisions of section 13-21-116 (2) (b), on and after April 23, 1992, any person who serves as a director, officer, or trustee of a nonprofit corporation or nonprofit organization and who is not compensated for serving as a director, officer, or trustee on a salary or prorated equivalent basis shall be immune from civil liability for any act or omission which results in damage or injury if such person was acting within the scope of such person's official functions and duties as a director, officer, or trustee unless such damage or injury was caused by the willful and wanton act or omission of such director, officer, or trustee.
For these purposes, the terms “nonprofit corporation” and “nonprofit organization” are limited to organizations that are exempt from tax under Sections 501(c)(2), (3), (4), (5), (6), (7), (8), (11), or (19) of the Internal Revenue Code (i.e., title–holding companies, charities, social welfare organizations, labor unions and agricultural and horticultural organization, trade associations, social clubs, fraternal organizations, teachers’ retirement funds, and certain veterans’ organizations).
It is unclear whether the legislature intended there to be any distinction between the “performance [of] duties as a board member” under C.R.S. § 13–21–116(2)(b) and “acting within the scope of such person’s official functions” within the meaning of C.R.S. § 13–21–115.7(2). In either case, liability may arise only with respect to willful and wanton acts or omissions.
More important, C.R.S. § 13–21–115.7(2) extends its protections to corporate officers and to the trustees of unincorporated (but tax–exempt) nonprofit associations. Previously, those individuals enjoyed no statutory protection at all.
One of the prerequisites to C.R.S. § 13–21–115.7(2)’s grant of immunity from civil liability is that the director or officer not be compensated. C.R.S. § 13–21–115.7(3) clarifies that neither the payment of expenses incurred in attending board meetings or in carrying out a particular office, the receipt of meals at meetings, nor the receipt of gifts throughout each year valued at less than $1,000 will be regarded as compensation for these purposes.
Protection is also denied if the injury results from the operation of a motor vehicle, aircraft, or boat.
Performance of Duties as a Board Member
C.R.S. § 13–21–116(2)(b) provides as follows:
No member of the board of directors of a nonprofit corporation or nonprofit organization shall be held liable for actions taken or omissions made in the performance of his duties as a board member except for wanton and willful acts or omissions.
While directors are still required to act prudently and to exercise their best judgment, they will not be liable to third parties unless they have acted in a manner that is wanton and willful. However, the effect of the exception for wanton and willful acts or omissions is uncertain.
The statute is apparently intended to protect directors from conduct that is simply negligent and to hold them liable only where their conduct has been considerably more egregious, but the boundaries between simple negligence, gross negligence, and willful and wanton acts or omissions are unclear and may likely depend on the whims of a jury.
In other words, if a jury determines for whatever reason that certain conduct in which the directors of a nonprofit corporation have engaged is so unreasonable as to be characterized as wanton and willful, then all of the protection which this statute offers is unavailable.
The statute applies only to the directors of a nonprofit corporation; it does not extend its coverage to acts or omissions which individuals may have taken or neglected to have taken in their capacity as officers, employees, members, agents, or volunteers of the nonprofit corporation.
Nor does the statute offer directors a significant degree of comfort. Potential plaintiffs are likely to name directors as defendants either because their financial resources appear promising or simply to attract their attention to the supposed merits of their claims. The statute does nothing to prevent a director from being sued, and thus offers no protection against the expense and anxiety of a lawsuit. It simply furnishes a defense that must be proved to the satisfaction of a jury.
Protection from Employee Torts
C.R.S. § 7–128–402(2), a provision of the Colorado Revised Nonprofit Corporation Act, provides as follows:
No director or officer shall be personally liable for any injury to person or property arising out of a tort committed by an employee unless such director or officer was personally involved in the situation giving rise to the litigation or unless such director or officer committed a criminal offense in connection with such situation. The protection afforded in this subsection (2) shall not restrict other common law protections and rights that a director or officer may have. This subsection (2) shall not restrict the nonprofit corporation's right to eliminate or limit the personal liability of a director to the nonprofit corporation or to its members for monetary damages for breach of fiduciary duty as a director as provided in subsection (1) of this section.
Unlike C.R.S. § 13–21–116(2)(b), discussed above, this provision applies equally to officers and directors.
Its protection, however, relates only to personal injury or property damage caused by an employee of the organization and is not available in circumstances where the director or officer participated in the activity giving rise to the lawsuit.
Presumably, although not yet tested in court, the statute would shelter a director from a lawsuit claiming that the director failed adequately to supervise the employee or should have known that the employee was incompetent, although this is arguably the sort of claim to which the statute is intended to relate.
Eliminating Liability to the Corporation
C.R.S. § 7–128–402(1), also a provision of the Colorado Revised Nonprofit Corporation Act, states as follows:
If so provided in the articles of incorporation, the nonprofit corporation shall eliminate or limit the personal liability of a director to the nonprofit corporation or to its members for monetary damages for breach of fiduciary duty as a director; except that any such provision shall not eliminate or limit the liability of a director to the nonprofit corporation or to its members for monetary damages for any breach of the director's duty of loyalty to the nonprofit corporation or to its members, acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, acts specified in section 7-128-403 or 7-128-501(2), or any transaction from which the director directly or indirectly derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director to the nonprofit corporation or to its members for monetary damages for any act or omission occurring before the date when such provision becomes effective.
In order for the protection available under this statute to become effective, a corresponding provision must be added to the corporation’s Articles of Incorporation, and the protection afforded by such a provision cannot apply to any act or omission which occurred prior to the date the provision became effective.
Again, it is important to observe that the statute extends its protection only to directors, not to officers, employees, members, and volunteers (many of whom, arguably, may not be subject to such a duty, however).
Also, the protection extends only to liability to the corporation, and not to any liability that a director may incur to other third parties.
For this reason, the incorporators of a new nonprofit corporation may wish to consider whether to include such a provision at all. While potential directors may insist on one, it may be in the corporation’s best interests not to limit the liability of directors to the corporation directly.
The overlap between the protection afforded by such a provision in the corporation’s Articles of Incorporation and that provided by C.R.S. § 7–128–401(4) is unclear. (The latter section states that “A director or officer is not liable as such to the nonprofit corporation or its members for any action taken or omitted to be taken as a director or officer, as the case may be, if, in connection with such action or omission, the director or officer performed the duties of the position in compliance with this section.”)
Uniform Nonprofit Unincorporated Association Act
The Uniform Nonprofit Unincorporated Association Act permits unincorporated associations to acquire, encumber, and transfer real and personal property and provides a level of immunity for their members similar to that of members of nonprofit corporation. C.R.S. § 7-30-101 et seq.
While the Act may be useful to some groups of people who loosely associate for the purpose of conducting some sorts of nonprofit activities, it probably should not be viewed as a planning opportunity.
While an unincorporated association may be able to qualify for exemption under Section 501(c)(3), it will still need to present the Internal Revenue Service with an organizational document that presumably will resemble Articles of Incorporation. If the association does not qualify for tax–exempt status, then its federal income tax status will probably be tested under the Internal Revenue Service’s regulations that attempt to distinguish partnerships from corporations. Formerly, under those regulations, since limited liability was one of the characteristics that caused an entity more closely to resemble a corporation than a partnership, the Act might make it a little more difficult for taxable unincorporated associations to avoid corporate classification. Now, under the “check the box” system, unless the association files an election to be treated as a corporation for federal tax purposes, it will most likely be classified by default as a partnership for federal tax purposes.
onetheless, the Act may be useful for organizations that previously qualified under Section 501(c)(3), but that lost their corporate charter for failure to have filed the required biannual corporate report.
In this regard, however, the Colorado Court of Appeals, in Sims v. Ottenhoff, 879 P.2d 436 (1994), held that directors of a nonprofit corporation who lacked any knowledge of the fact that the corporation had been involuntarily dissolved because of its failure to have filed corporate reports could not be held liable for the negligent conduct of an employee.
The Court concluded that C.R.S. § 7–20–106 (now codified at C.R.S. § 7–122–104), which stated that “[a]ll persons who assume to act as a corporation without authority to do so shall be jointly and severally liable for all debts and liabilities incurred or arising as a result thereof,” applies only when persons act as a purported corporation without making any bona fide effort to achieve corporate status.
Federal Volunteer Protection Act (42 U.S.C. § 14501 et seq.)
Statutory Findings
(1) the willingness of volunteers to offer their services is deterred by the potential for liability actions against them;
(2) as a result, many nonprofit public and private organizations and governmental entities, including voluntary associations, social service agencies, educational institutions, and other civic programs, have been adversely affected by the withdrawal of volunteers from boards of directors and service in other capacities;
(3) the contribution of these programs to their communities is thereby diminished, resulting in fewer and higher cost programs than would be obtainable if volunteers were participating;
(4) because Federal funds are expended on useful and cost-effective social service programs, many of which are national in scope, depend heavily on volunteer participation, and represent some of the most successful public-private partnerships, protection of volunteerism through clarification and limitation of the personal liability risks assumed by the volunteer in connection with such participation is an appropriate subject for Federal legislation;
(5) services and goods provided by volunteers and nonprofit organizations would often otherwise be provided by private entities that operate in interstate commerce;
(6) due to high liability costs and unwarranted litigation costs, volunteers and nonprofit organizations face higher costs in purchasing insurance, through interstate insurance markets, to cover their activities; and
(7) clarifying and limiting the liability risk assumed by volunteers is an appropriate subject for Federal legislation because -
(A) of the national scope of the problems created by the legitimate fears of volunteers about frivolous, arbitrary, or capricious lawsuits;
(B) the citizens of the United States depend on, and the Federal Government expends funds on, and provides tax exemptions and other consideration to, numerous social programs that depend on the services of volunteers;
(C) it is in the interest of the Federal Government to encourage the continued operation of volunteer service organizations and contributions of volunteers because the Federal Government lacks the capacity to carry out all of the services provided by such organizations and volunteers; and
(D) (i) liability reform for volunteers, will promote the free flow of goods and services, lessen burdens on interstate commerce and uphold constitutionally protected due process rights; and
(ii) therefore, liability reform is an appropriate use of the powers contained in article 1, section 8, clause 3 of the United States Constitution, and the fourteenth amendment to the United States Constitution.
Constitutionality. Given these rationale and recent trends in the United States Supreme Court’s attitude towards the scope of the Commerce Clause, it is quite possible that the federal Volunteer Protection Act would be declared unconstitutional. After all, if the Court is unwilling to uphold the constitutionality of federal legislation banning handguns in school zones (U.S. v. Lopez, ___ U.S. ___ (April 26, 1995)) or granting victims of rape a private right of action (U.S. v. Morrison, ___ U.S. ___ (May 15, 2000)), it may not give much credence to congressional concerns that “volunteers and nonprofit organizations face higher costs in purchasing insurance, through interstate insurance markets” and that “services and goods provided by volunteers and nonprofit organizations would often otherwise be provided by private entities that operate in interstate commerce.”
Federal Preemption. 42 U.S.C. § 14502 provides that the federal law “preempts the laws of any State to the extent that such laws are inconsistent with this chapter, except that this chapter shall not preempt any State law that provides additional protection from liability relating to volunteers or to any category of volunteers in the performance of services for a nonprofit organization or governmental entity.” Given the remarkable similarities between the federal statute and C.R.S. § 13–21–115.5, it is unlikely that Colorado’s law has been preempted. The federal statute, however, also permits the states to enact specific legislation, citing 42 U.S.C. § 14502(b), that renders the federal law inapplicable.
Definitions.
Nonprofit Organization: any organization which is described in section 501(c)(3) of the Internal Revenue Code and which does not practice any action which constitutes a hate crime referred to in subsection (b)(1) of the first section of the Hate Crime Statistics Act (28 U.S.C. 534 note) or any other any not-for-profit organization which is organized and conducted for public benefit and operated primarily for charitable, civic, educational, religious, welfare, or health purposes and which does not practice any action which constitutes a hate crime;
Volunteer: an individual performing services for a nonprofit organization or a governmental entity who does not receive - (A) compensation (other than reasonable reimbursement or allowance for expenses actually incurred); or (B) any other thing of value in lieu of compensation, in excess of $500 per year, and such term includes a volunteer serving as a director, officer, trustee, or direct service volunteer.
Protection Available. The key to the federal statute is 42 U.S.C. § 14503(a), which provides as follows:
Except as provided in subsections (b) and (d) of this section, no volunteer of a nonprofit organization or governmental entity shall be liable for harm caused by an act or omission of the volunteer on behalf of the organization or entity if —
(1) the volunteer was acting within the scope of the volunteer's responsibilities in the nonprofit organization or governmental entity at the time of the act or omission;
(2) if appropriate or required, the volunteer was properly licensed, certified, or authorized by the appropriate authorities for the activities or practice in the State in which the harm occurred, where the activities were or practice was undertaken within the scope of the volunteer's responsibilities in the nonprofit organization or governmental entity;
(3) the harm was not caused by willful or criminal misconduct, gross negligence, reckless misconduct, or a conscious, flagrant indifference to the rights or safety of the individual harmed by the volunteer; and
(4) the harm was not caused by the volunteer operating a motor vehicle, vessel, aircraft, or other vehicle for which the State requires the operator or the owner of the vehicle, craft, or vessel to — (A) possess an operator's license; or (B) maintain insurance.
Punitive Damages. In addition, 42 U.S.C. § 14503(e) limits punitive damages, as follows:
Punitive damages may not be awarded against a volunteer in an action brought for harm based on the action of a volunteer acting within the scope of the volunteer's responsibilities to a nonprofit organization or governmental entity unless the claimant establishes by clear and convincing evidence that the harm was proximately caused by an action of such volunteer which constitutes willful or criminal misconduct, or a conscious, flagrant indifference to the rights or safety of the individual harmed.
Exceptions to Immunity.
crimes of violence (as that term is defined in section 16 of title 18) or act of international terrorism (as that term is defined in section 2331 of title 18) for which the defendant has been convicted in any court;
hate crimes (as that term is used in the Hate Crime Statistics Act (28 U.S.C. 534 note));
exual offenses, as defined by applicable State law, for which the defendant has been convicted in any court;
misconduct for which the defendant has been found to have violated a Federal or State civil rights law; or
where the defendant was under the influence (as determined pursuant to applicable State law) of intoxicating alcohol or any drug at the time of the misconduct.
Internal Corporate Protections
Indemnification
In 1987, the Colorado legislature broadened the circumstances under which nonprofit corporations must or may indemnify their officers, directors, and employees. It is now possible for nonprofit corporations to adopt provisions that indemnify their governing bodies far more generously than may previously have been the case.
The only difficulty with indemnification is that its protection depends on the availability of sufficient assets of the indemnifying organization. In the case of an organization whose assets are limited, indemnification may offer no protection at all. On the other hand, if the assets available for indemnification are substantial, then adoption of extensive provisions for the indemnification of officers and directors may be appropriate.
Often the most difficult task facing a newly elected board member is simply becoming acquainted with the activities and plans of the organization. An uninformed board member is an ineffective and possibly dangerous one, and so one of the greatest services that the full–time staff and other board members can render is to provide incoming board members with a comprehensive orientation. The orientation should cover such topics as the organization’s management structure, the nature of its current activities, its plans for the future, its financial condition and financial management, and possibly significant events from its past that may have a continuing significance.
Board members should also receive instruction as to their legal responsibilities and the expectations that the organization will place upon them, such as fundraising, special areas of expertise, and the like.
On an on–going basis, it is the responsibility of every board member to keep himself fully informed as to the size, complexity, and structure of the organization, pending transactions, and operating policies. The board should seek outside legal, financial, or other counsel where the complexity of pending decisions warrant or where special expertise is otherwise appropriate. Each board member should ensure that he is adequately informed to make a prudent judgment, should satisfy himself that the executive staff has considered and presented all available information and alternatives, and fully participate in the decision–making process.
Directors and Officers Liability Insurance
General Considerations.
None of the statutory protections discussed above can prevent a lawsuit from being brought against the officers and directors of a nonprofit organization. While these protections may provide a valid and effective defense against such a lawsuit, it is important to keep in mind that they in no way eliminate the necessity and expense of defending the lawsuit. At best, while a director may in certain circumstances be able successfully to raise one of these statutory defenses in a motion for summary judgment, the director will still be responsible for bearing the cost of such a defense.
If the risks are significant and the corporation’s promise of indemnity is not supported by its financial resources, then liability insurance may prove to be the only way of satisfying a board that its individual members will not personally have to bear the expense of defending themselves. In light of the protections described above, liability insurance might be viewed as a sort of pre–paid legal plan for a nonprofit corporation, where the insurance against paying a judgment is perhaps secondary in importance to protection against the costs of litigation.
Premiums for officers’ and directors’ liability insurance have increased enormously within the past decade, and so the board of directors needs to assess its exact exposure and weigh that risk against the cost of obtaining insurance protection.
Scope of Coverage.
Insured Parties. Most directors’ and officers’ liability policies will insure the officers and directors, although the protection afforded to them may apply only in connection with acts within the scope of their duties as such. The policy should also be reviewed to determine whether its protection extends to employees and volunteers in connection with their acts on the corporation’s behalf. It is likely that no protection will be available with respect to actions by those individuals that are either unauthorized or taken in something other than in an official capacity.
Exclusions From Coverage. Often of greater significance than what types of actions the policy may attempt to insure are the exceptions from coverage, which are likely to be far more specific.
A policy will typically not cover dishonest, fraudulent, malicious, or knowingly wrongful acts.
It may not cover any relationship with any business activity that is not specifically named in the policy.
It may not cover damages for personal injury to an employee or liability under a workmen’s compensation or similar statute.
It may not insure against punitive or exemplary damages, although it is possible that the insurance company may defend an action seeking punitive damages, if the subject of the lawsuit would otherwise fall within the scope of coverage.
It will likely not cover any liabilities assumed in any contract or agreement. It may not cover damages arising out of discrimination as a result of race, creed, age, or sex.
Claims Procedures. Many policies are “claims made” policies, which means that their coverage extends only to claims that the organization actually submits to the insurance company during the policy period and that have arisen out of events that occurred after the initial effective date of the policy and before its termination. If the policy is discontinued, it may be necessary to obtain “tail” coverage for claims submitted after the date of termination.
Limits of Coverage. A policy may state that the insurance company will pay all claims expenses (essentially legal fees and other investigation and defense costs) “in addition to the applicable limits of liability.” Other policies may indicate that the limits of liability include defense costs. In the latter case, the available coverage will be reduced by the amount the company spends to defend the suit. Since it is entirely possible to spend tens of thousands of dollars defending a lawsuit, the actual coverage may be significantly less than the policy amount.
