If you have attended one of the workshops presented by Pro Bono Partnership that includes a discussion on nonprofit governance, you likely have heard us talk about the three legal duties of nonprofit trustees and officers.
In New Jersey, these duties arise out of the New Jersey Nonprofit Corporation Act, which includes the requirement that “Trustees … shall discharge their duties in good faith and with that degree of diligence, care and skill which ordinary, prudent persons would exercise under similar circumstances in like positions.”
The first duty is the duty of care, which obligates trustees and officers to take reasonable measures to ensure that the nonprofit has adequate resources, prudently manages those resources, and doesn’t violate the law.
The second duty is the duty of loyalty, which requires that trustees and officers put the best interests of the nonprofit first and disclose any actual or potential conflicts of interest.
The final duty, which some — including me — argue is subsumed within one or both of the first two duties, is the duty of obedience, which mandates that trustees and officers ensure that the nonprofit operates in accordance with the mission and purposes set forth in its filings with its state of incorporation and the IRS.
I recently read a court decision, In Re Preliminary Contract Financial Settlements on The Center for Family Support’s Contracts, which made me think that perhaps we should break out a fourth duty, one that likely is subsumed within the duty of care: the duty to read. This duty, like the other ones, would apply to both trustees and officers, but would also apply to anyone with the responsibility to understand and implement contracts entered into by the nonprofit.
According to the decision of the Appellate Division of the New Jersey Superior Court, The Center For Family Support (Center) entered into two contracts with the NJ Division of Developmental Disabilities (Division), which is within the NJ Department of Human Services (Department). Like many contracts, especially government contracts, the contracts in question incorporated by reference standard terms and conditions that were set forth in appendices, regulations, and contracting manuals.
One key clause of the contracts stated:
“In the administration of this [c]ontract, the Provider Agency shall comply with all applicable policies and procedures issued by the Department including, but not limited to, the policies and procedures contained in the Department’s … Contract Policy and Information Manual [(Manual)] (as from time to time amended). Failure to comply with these policies and procedures shall be grounds to terminate the contract.”
One such policy document is Policy Circular P1.10, which sets forth the procedures a provider must follow in order to modify the contract during its term. According to the court, pursuant to this circular, “if the provider has agreed in the contract that it will spend a specified amount for a particular service during the contract year, it may not exceed that amount without first obtaining a written contract modification approved by the Division. In addition, the provider may not transfer funds from other budget categories to cover cost overruns in a different budget category unless it has obtained prior Division approval.”
The Center exceeded its budget for particular line items and shifted funds from other budget categories to those line items. It never sought Division approval to do so.
The Division sought to recover nearly $900,000 in allegedly improper expenditures and misspent funds. In the ensuing legal battle, which is still ongoing, the Center argued that it was improper for the Division to incorporate the Manual by reference into the contracts.
I won’t bore you with the details of that legal argument, as it isn’t relevant to the three morals of this story and the court flat out rejected it. The litigation will continue with respect to other issues, such as the exact amount that the Center might eventually need to repay.
The first moral of this story is simple: don’t sign a contract until you have read all the terms and are willing to abide by them. You have to read through those annoying, often small-print appendices, regulations, and contracting manuals. You are not a legislator, who can get away with voting to approve legislation without having read the 100 pages of text.
If you aren’t willing to read all of the provisions of contracts, then don’t sign them, and forget about ever seeking any government contracts or grants in the future. Foregoing contracts and grants the nonprofit might easily qualify for simply because you won’t read the “fine print” might itself be a breach of the duty of care to ensure the financial well-being of the nonprofit.
The second moral is equally simple: if you execute a contract that requires the nonprofit to jump through hoops A, B, and C in order to modify the terms of the contract, then start jumping before you change the contract terms or deliverables. If you don’t, you put your nonprofit at significant risk and yourself at risk of breaching your duty of care to the nonprofit.
The final moral is that trustees need to be sure they have put officers in charge who understand the first two points. Trustees should also consider adopting a signatory authority policy that sets forth at what levels in the organization contracts need to be approved. In such a policy, higher levels of approval are required as the dollar value of contracts increases and/or based on the subject matter of the contract.
PS: The duty to read also requires trustees and officers to read, understand, and follow the terms of the nonprofit’s Certificate of Incorporation and Bylaws. If the trustees are unhappy with the requirements of these documents, they need to amend them instead of ignoring them, as was the case in Sparks v. Doby, another case decided by the Appellate Division, a year ago this month.
Want to learn more? Check out:
- National Council of Nonprofits’ Board Roles and Responsibilities
- Pro Bono Partnership’s Corporate Governance and Compliance Learning Center
- The Bridgespan Group’s Fiduciary Responsibilities of Board Members
- The Bridgespan Group/BoardSource Nonprofit Board Resource Center
Christine Michelle Duffy is a senior staff attorney with Pro Bono Partnership and a participant in the Members Consultative Group for The American Law Institute’s (ALI) Restatement of the Law of Charitable Nonprofit Organizations. At its 2016 annual meeting, the ALI membership approved Chapter 2 (Governance) of the draft Restatement, which rejects the concept of a separate duty of obedience. Earlier this month and on the same day, Christine celebrated Christine’s thirtieth wedding anniversary and the twenty-eighth birthday of Christine’s daughter. To learn more about Pro Bono Partnership, or to donate, please visit www.probonopartner.org or call (973) 240-6955.