Pro Bono Partnership Pundit: How to Spot and Address Conflicts of Interest in the Board Room

Posted on by Dodge
Avoiding board conflicts of interest can feel like a tug of war.

Avoiding board conflicts of interest can feel like a tug of war.

We’ve all seen the headlines about possible conflicts of interest in the news lately, in stories of national interest and importance.  The topic is also important for all nonprofits to understand and address properly, regardless of whether those organizations’ activities may make the headlines.

Pro Bono Partnership receives frequent questions about what may constitute a conflict of interest and the board’s responsibilities in the face of potential conflicts.  Conflicts of interest arise any time a board member’s duty of loyalty to make decisions and enter into transactions that are in the best interests of the organization may be at odds with the trustee’s personal or financial interests, or with their other volunteer or professional obligations.

Here are a few examples to consider.  A board member might own a restaurant and offer to have it cater all board events at a “good price.”  Another trustee’s family member runs a software company, and the Technology Committee, which this trustee chairs, has decided that the best software for the nonprofit is provided by this company.  Your landlord, an individual who has always been supportive of your organization’s work, wants to serve on the board.

Do any of these situations present a conflict of interest?

All of the situations above are examples of potential conflicts of interest, because each situation creates a tension between the board member’s (or their family member’s) financial interest and the interest of the nonprofit.  The fact that the situations present conflicts does not, however, automatically require that the nonprofit avoid these transactions.  To the contrary, it will often be in the best interests of a nonprofit to receive services from an interested party, particularly when the services are offered at below-market rates.

What should the thoughtful board do?

The board should follow the procedures in its conflict of interest policy.  A conflict of interest policy is one of the most important corporate governance policies an organization can have.  So if your board doesn’t have a conflict of interest policy, it should strongly consider adopting one.  It may be a standalone policy, or contained in the organization’s bylaws.

While New Jersey doesn’t have a specific requirement, having a conflicts policy clearly supports good governance and compliance by the board with its fiduciary duties.  New York nonprofits are required to have a conflict of interest policy that conforms to certain statutory requirements.  At the federal level, the application for tax-exempt status, Form 1023, and the long form annual informational tax return, Form 990, also ask organizations if they have a written conflict of interest policy.

How do conflict of interest policies work?

These policies outline a procedure that boards must follow when conflict transactions are proposed.  In such a situation, the board member must disclose the conflict and all the pertinent facts to the rest of the board, and the board member should not participate in the deliberations and vote of the independent board members.

Disclosure is a critical step, because if board members aren’t aware that a transaction could present a conflict, they will not raise the issue with the rest of the board.  Some boards have an agenda item for each meeting that reminds members to disclose potential conflicts for any items on the agenda, and many policies require that board members complete an annual certification as to conflicts.

Conflicts may be less obvious than the examples above, such as where an individual sits on the boards of two different nonprofits.  Even if the organizations are not providing the same type of services to the community, there may be conflicts over applying for the same funding, or one of the organizations may make grants to the other.

The independent board members must satisfy themselves that the services are of the quality and quantity that the nonprofit needs.  They also must decide whether the compensation or cost of the services is appropriate, which requires that they understand whether the cost of goods or services provided is at, below, or above the market rate.

The independent board members then must make an informed judgment as to whether it is in the nonprofit’s best interest to enter into the transaction, taking into account not only cost, but also how the transaction might impact the board’s or organization’s dynamics, and how it will appear to those in the larger community.  For example, if many local software vendors have expressed interest in selling their product to the nonprofit, might the community see a decision to award the job to a trustee’s relative as unfair competition?

If a decision is made to move forward with a transaction, the nonprofit should take steps to make sure that the services or goods that have been ordered are delivered and that the interested board member has no involvement in the transaction.

Last, but importantly, the rationale for the board’s decision should be documented in the minutes of the meeting.  While documentation may not protect the organization from criticism, it can provide an important shield to claims that the board violated its conflict of interest policy or the board members violated their fiduciary duties.

Please contact Pro Bono Partnership if you have questions about conflicts of interest or if you’d like to see a sample conflict of interest policy for board members.  To read more about conflicts and view a sample policy, see the article on our website.


20160108_Nancy_025cNancy Eberhardt is New Jersey director of Pro Bono Partnership and a regular contributor to the Dodge Blog.  Pro Bono Partnership provides free business and transactional legal services to nonprofits serving the disadvantaged or enhancing the quality of life in neighborhoods in New York, New Jersey and Connecticut.  To learn more about Pro Bono Partnership, please visit www.probonopartner.org or call (973) 240-6955.

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