Conflicts can arise whenever a nonprofit’s directors’ personal interests are impacted by decisions they make on behalf of the nonprofit. Undisclosed or unresolved conflicts can lead to serious questions about an organization’s integrity, undermine its fundraising efforts, and in extreme cases can threaten its tax-exempt status.
What is a conflict of interest?
Typically, conflicts of interest arise where the director, another organization owned or managed by the director, or a member of the director’s family stands to benefit by a transaction with the nonprofit. When the director stands to gain personally from a transaction, it can raise concerns that his or her approval of a transaction, contract, or policy is not solely based on the best interests of the nonprofit.
Conflicts of interest fall within a spectrum, from transactions that are overwhelmingly favorable to the director to cases where the director or the director’s family may receive some incidental benefit. Some examples of potential conflicts of interest include:
- Self-dealing transactions, defined in California as those in which the director will have a material financial interest and that aren’t covered by an exception.
- Employment agreements and contracts with the director, the director’s company, or the director’s family members.
- Services provided to a director or the director’s family, especially if provided for a discount.
- Excess benefit transactions, a federal tax law concept that captures transactions where a nonprofit is paying more than the actual value for goods or services.
Managing conflicts of interest
Just because a director or the director’s family will benefit in some way from a transaction doesn’t necessarily mean that the transaction cannot go forward. Unless the organization’s governance documents expressly prohibit transactions involving conflicts of interest, there is no legal prohibition against them per se. Cases of self-dealing and excess benefit transactions can make agreements void and lead to tax liability, but the wider problem is often the reputational harm that comes with directors seeking personal gain from their involvement with a nonprofit.
A director’s duty of loyalty includes an ethical obligation to disclose their personal interest in transactions that are before the board for approval. Boards can get ahead of problems in this area by adopting clear policies regarding what the organization defines as a conflict of interest and how they will be addressed. In many cases the solution is simply that the interested director doesn’t vote on the transaction. But some transactions may call for more robust practices, especially if the financial value is substantial.
The Church Law Center of California advises churches and other nonprofits on how to protect themselves from risk while furthering their mission. Call us today at (949) 245-3177 or reach out to us through our contact page.