How Nonprofit Managers Can Distinguish Between Institutional and Personal Risk

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There are many who say that running an organization is chiefly about managing risk. In the nonprofit realm, managing risk often involves a mixture of revenue generation, careful financial management, and giving due consideration to legal and tax compliance.  A nonprofit’s leaders have an obligation to treat the welfare of the organization as a top priority. But at the same time, they also need to be conscious of potential sources of personal risk.

Directors of nonprofits who come from the for-profit world probably already have a sense of what limited liability means. The law provides limited liability to individuals in leadership positions at organizations that meet certain requirements. So long as those requirements are met, qualified individuals typically will not be held personally responsible for the debts and liabilities of the organization.

If an organization is operated without incorporating, under California law it will be treated as an unincorporated nonprofit association. As an unincorporated association, the legal existence of the nonprofit rests solely upon the agreement of the people involved. In some states, the members and directors of unincorporated associations are personally liable for the debts of the organization, under the theory that the organization does not have independent existence apart from its members. Not so in California, which extends certain limited liability protections to members and directors of an unincorporated association.

For a number of reasons, many profits choose to incorporate a nonprofit corporation. One good rationale for doing this is the more robust personal liability protections that a corporation offers to its directors.

The limited liability provided by legal entities has certain important limits that are worth keeping in mind for members, directors, and officers:

  • Leaders and agents can be held personally responsible for obligations that they personally assume. For example, offering a personal guarantee that the organization will pay a debt may create a personal obligation.
  • Individuals can be held personally responsible for the consequences of torts, like causing a personal injury or committing an act of fraud.
  • Directors can become personally liable to the organization or other stakeholders if they breach their fiduciary obligations in certain ways.
  • Certain transactions that qualify as self-dealing or excess benefit transactions under tax rules may expose the directors and officers involved to tax liability.

The Church Law Center of California advises religious and secular nonprofits on matters of governance. We are happy to help leadership teams better understand their rights and obligations. To schedule an appointment call us at (949) 892-1221 or reach us through our contact page.

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