When are non-profit directors in New York personally liable for their actions?

October 27, 2021

The COVID-19 pandemic has impacted non-profits in a number of ways, with many seeing their funding reduced, leading to staffing cuts and the rollback of services. The loss of funding can lead grant-reliant non-profits to make the difficult choice to cease operations.

This decision is often precipitated by a number of months of uncertainty while the organization continues to spend the funds/make financial decisions necessary for continued operations, but that may, in hindsight, seem imprudent considering the organization’s ultimate dissolution. Fearful of these decisions being scrutinized, directors and officers often question whether they could face personal liability for decisions.

In New York, two preliminary questions must be answered before determining the extent of the personal liability of non-profit officers and directors .

(1)   Whether the director or officer is compensated or not (reimbursement for the cost of attending meetings does result in a director being considered compensated). If the director is not compensated, then under § 720-a of the Not-for-Profit-Corp law, they are only potentially liable to third parties where their actions “with respect to the person asserting liability constituted gross negligence or was intended to cause the resulting harm to the person asserting such liability”.

(2)   Whether the non-profit is insolvent, approaching insolvency, or contemplating bankruptcy or dissolution. This question is important, because the directors of such entities owe a fiduciary duty to creditors (i.e. those to whom the entity owes money), though this duty must be balanced with the nonprofit’s mission (more on that below).  

In the ordinary course (i.e. in cases of nonprofits not approaching insolvency),  non-profit directors owe a fiduciary duty to the non-profit, which in practical terms means they owe a duty to “discharge the duties of their respective positions in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions”. Moreover, non-profit directors are protected by the “business judgment rule” which protects them from liability if they can demonstrate that they exercised their duties “in good faith, in an informed manner, and did not personally benefit from their actions”. Accordingly, a non-profit director which votes for a risky course of action, albeit in good faith and after having reviewed all relevant available information, will generally be insulated from personal liability.

For those nonprofits approaching insolvency, or that are already insolvent, the equation is different. In this situation, the directors have a fiduciary duty (i.e. a duty to act in another’s best interest) to preserve corporate assets for the benefits of creditors (i.e. those to whom money is owed). A complicating factor however, is the requirement to balance the interest of creditors with the preservation/observation of the nonprofit’s charitable purpose. Exactly how this is to be carried out is unclear. In the leading case on the matter - In re HHH Choices Health Plan, LLC, the court (SDNY) had to opine on whether the sale of a non-profit’s senior housing facility to a particular bidder was contrary to New York law. While reviewing the relevant law, the court posited a hypothetical – what if there were two competing bids – one was for market value that would satisfy the creditors but would lead to the closure of the facility, while the other was significantly under market-value, but would permit the facility to continue operations? The court arrived at no concrete conclusion, other than that a balancing was necessary, and that a wholly “mission” centered view was not supported by law.

So ultimately, non-profit officers and directors should not face personal liability for informed decisions made in good faith. Where the nonprofit has valuable assets – for example real estate – particular care should be taken by officers and directors when making decisions regarding these assets due to the higher likelihood that the sale will require approval in bankruptcy court. In these instances, officers/directors should not hesitate to seek the advice of legal counsel or financial advisers due to the anticipated heightened scrutiny.