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Introduction
All directors of nonprofit corporations have a “duty of loyalty” that requires them to put the
interests of the organization above their personal interests and to make decisions they believe are in the best interest of the nonprofit. Individuals who have a personal financial interest in the affairs of a charitable organization may not be as likely to question the decisions of those who determine their compensation or fees or to give unbiased consideration to changes in management or program activities.-
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The founders of a nonprofit corporation sometimes initially turn to family members and business
partners to serve on its board of directors, but interlocking financial relationships can increase
the difficulty of exercising the level of independent judgment required of all board members. It is therefore important to the long-term success and accountability of the organization that a sizeable majority of the individuals on the board be free of financial conflicts of interest.This principle does not apply to private foundations and certain medical research institutions that operate under specific legal restrictions regarding self-dealing transactions, and other charitable organizations whose articles of incorporation or trust instruments include special stipulations regarding board composition. For example, an organization established under the auspices of a religious institution may be required to include clergy or other paid representatives of that institution on its board. A supporting organization may be required to have representatives of its supported organizations on its board. For a complete list of the types of organizations excluded from this principle, consult the reference addition of these
principles at www.nonprofitpanel.org.When a charitable organization determines that having a majority of independent board members is not appropriate, the board and staff should evaluate their procedures and meeting formats to ensure that board members are able to fulfill their responsibilities to provide independent, objective oversight of management and organizational performance.
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Core Concepts
- The “duty of loyalty” requires board members to put the interests of the organization above personal interests.
- A nepotism policy, forbidding favoritism shown to family members and friends, could help some organizations promote independence among board members and senior staff.
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Legal and Compliance Issues
- The IRS Form 990 inquires how many independent board members the organization has.
- The IRS defines the term “independent” board member.
- Some state laws set the minimum limit for independent board members.
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Legal Background
Five states have legislative mandates for the independence of nonprofit boards of directors. North Dakota,1 Maine,2 California,3 and Vermont4 require that no more than 49% of the board may be “interested” or “financially interested” persons. While the definitions vary slightly in each state, “financially interested” persons are generally those who have received or are entitled to receive compensation for personal services rendered to the organization (other than compensation for board service), and/or those who are related family members of compensated persons.5 New Hampshire requires that at least five voting members of the board of a charitable corporation “are not of the same immediate family or related by blood or marriage.”6 The New Hampshire provision does not apply to private foundations, and certain religious organizations including churches and integrated auxiliaries of churches.(From The Principles for Good Governance and Ethical Practice: Reference Edition,
Published in 2007)1 ND Cent. Code § 10-33-27.
2 Maine Nonprofit Corporation Act, Title 13-B, § 713-A (2).
3 Cal. Corp. Code § 5227 (a).
4 11B VT Stats § 8.
5 Maine and Vermont define related parties as “spouse,
brother, sister, parent or child,” while California also includes
ancestor, descendant, brother-in-law, sister-in-law, son-in-law,
daughter-in-law, mother-in-law, or father-in-law.
6 N.H. Rev. Stat. § 292:6-a. -
Discussion Points
These questions – from the Principles Workbook (PDF) – are intended to prompt discussion about the principle, assess the polices and practices of your organization, and encourage your organization to take steps to identify where improvements should be made.
- Do we adequately understand how the IRS (and state law, if applicable) define independent members? Have we taken the necessary steps to document that a substantial majority of the board fits the criteria?
- What are the dangers of “interlocking financial relationships” among board members, and how could these financial conflicts of interest affect the long-term success of an organization?
- Do we understand the types of organizations that are exempt from this principle and have we determined whether this applies to our organization? (If not sure about the applicability, please see the reference section of this clause in the Reference Edition of the Principles www.nonprofitpanel.org/report/principles/Principles_Reference.pdf)
- If our organization has reasonably determined it is appropriate not to have a majority of independent board members (for example, we are a family foundation), what steps have we taken or should we be taking to fulfill our responsibility to provide independent oversight?
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Resources for Principle #12
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Related Principles
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Supplemental Materials
