Enforcing the Duties of Nonprofit Fiduciaries: Advocating for Expanded Standing for Beneficiaries (2016)

INTRODUCTIONOversight of the nonprofit sector has long been a public concern.1 Nonprofits are largely self-regulated; otherwise, authority to exercise oversight is largely in the hands of states' attorneys general and the federal Internal Revenue Service (IRS). The public may vote with their dollars; innovations such as signaling intermediaries have helped the public vet organizations before they donate. In the for-profit context, the company's owners may exercise at least a limited amount of oversight over the company's board of directors through voting for board members, submitting stockholder proposals, and bringing lawsuits against the board members. By contrast, nonprofits do not have owners to which they are accountable. This stems from the defining feature of nonprofit corporations: the nondistribution constraint.2 Although nonprofits may and do earn profits,3 nonprofits may not distribute these profits to owners, directors, or trustees.4 Standing in litigation against nonprofit boards of directors should be expanded to allow nonprofit beneficiaries to file lawsuits similar to stockholder derivative lawsuits in the for-profit context. Expanding standing to include beneficiaries will improve nonprofit oversight. Significantly, plaintiffs will have the ability to access nonprofits' books and records and remove misbehaving directors. Nonprofits serve the public interest, and the public should be able to take a more active role in overseeing them.5I. NONPROFIT FIDUCIARY DUTIESWhile nonprofit boards have many functions,6 the fiduciary obligations of board members are the simple law fiduciary principles derived from common law agency:7 the duty of care and the duty of loyalty.8 While some proposals for expanding standing also advocate for widening the scope of permitted claims,9 this Essay will advocate only for expanded enforcement of fiduciary duties.The fiduciary duties of nonprofit directors are less stringent than those imposed on trustees.10 One of the first cases to apply these fiduciary standards to nonprofit directors was Stern v. Lucy Webb Hayes National Training School for Deaconesses & Missionaries,11 which stated that the standard, rather than the more stringent trust standard, would apply to nonprofit directors.12 The architects of the Model Nonprofit Corporation Act followed this approach.13A. The Duty of CareThe duty of care is the standard of conduct pursuant to which directors discharge their responsibilities.14 Directors must fulfill their responsibilities diligently and make informed decisions.15 Only actions (or failures to act)16 that amount to gross negligence are considered violations of the duty of care.17 However, courts do not often find that a director has violated her duty of care because of the business judgment rule,18 which is a judicial presumption that board members act in an informed manner, in good faith, and in the best interest of the corporation.19 Derived from the for-profit context, the business judgment rule also applies to nonprofit directors.20 In practice, nonprofit directors are held to an even lower standard than directors.21 The theory behind the business judgment rule is that authorities and judges should not second-guess board members' business decisions.22 However, the business judgment rule does not apply when directors abdicate their responsibilities and fail to act or act in bad faith.23B. The Duty of LoyaltyThe duty of loyalty requires directors to act in the nonprofit's best interest rather than their own.24 A director violates the duty of loyalty when she engages in self-dealing or uses her position improperly to obtain a personal benefit.25 Directors are also barred from usurping corporate opportunities that belong to the nonprofit organization.26 Plaintiffs have greater success bringing claims alleging duty of loyalty violations because corporations cannot limit a director's personal liability for duty of loyalty breaches27 and the burden is on the director to prove the good faith and inherent fairness of the transaction. …