Conflicts of interest within a nonprofit’s leadership group can create thorny problems for the organization if they are not properly managed. 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. Adopting and following a clear conflicts policy is a good way to ensure that potential conflicts are addressed while preserving opportunities that directors can offer.
What is a conflict of interest?
A director can have a conflict of interest in a range of situations. In general terms, they arise where the director, another organization owned or managed by the director, or a member of the director’s family stands to gain by a transaction with the nonprofit. When the director stands to benefit personally from a transaction, it can raise concerns that his or her approval of the deal is not solely based on the best interests of the nonprofit.
Conflicts of interest fall within a spectrum. On one side are transactions that are overwhelmingly favorable to the director. For example, a real estate transaction in which the nonprofit will pay well over market value for land owned by the director’s spouse is an unmistakable case where the director should not be involved in approving the deal. On the other end of the spectrum are cases where the director or the director’s family may receive some incidental benefit. An organization that funds school programs probably doesn’t need to worry if a director’s niece is among the pupils who will attend in the ordinary course.
Some examples of potential conflicts of interest include:
- 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.
- 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. Corp. Code § 5233(d).
- 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. 26 U.S.C. 4958(c)(1)(A).
Responding to 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 high.
An experienced nonprofit lawyer can assist you
The Church Law Center of California provides guidance to religious and secular nonprofits on all aspects of governance. If you have questions about how your organization can best manage potential conflicts of interest, call us today to see if we can be of help. We can be reached at (949) 892-1221 or through our contact page.