The most unique aspect of a not for profit corporation is that in return for tax exemption from the State and Federal governments, the not for profit entity is held to a much higher degree of scrutiny by government authorities. And the reason is simple: the special status means that the government has a continuing interest to assure that the purpose and goals of the entity is being utilized appropriately for nonprofit purposes to maintain the special tax status.
All too often unscrupulous persons seek to evade taxes by use of the nonprofit entity and the most common method is to use foundation resources for personal gain. Too high salary to founders or family; purchase of assets or travel that are mainly to the benefit of the founders or family; payment of expenses that should not be subsumed within the nonprofit purpose; fringe benefits out of keeping with the actual assets of the entity or its resources; and entering into self-dealing contracts that benefit the founders and not the not for profit are the common claims against founders by the government.
The board of a nonprofit must carefully take steps to avoid falling into any of these traps and it is not uncommon for the board and the chief executive officers to disagree as to what is appropriate and how to avoid dangers inherent in corporate opportunities.
All these issues fall within the purview of “conflicts of interest” in that the founder or other fiduciary of the nonprofit has acted in a way in that his or her interest actually conflicts with the best interest of the nonprofit.
A policy governing conflicts of interests is perhaps the most important policy a nonprofit board can adopt. To have the most impact, the policy should be in writing and the board and employed staff of the nonprofit should review the policy regularly to ensure it remains relevant.
Often founders or persons involved in the nonprofit act quite innocently and are unaware that their activities or personal interests are in conflict with the best interests of the nonprofit. A goal for many organizations is to simply raise awareness, encourage disclosure and discussion of anything that could conceivably be a conflict, and create a “culture of candor.”
Many nonprofits make it a regular practice to take time at a board meeting once a year to discuss the types of hypothetical situations that could result in a conflict of interest, and then discuss how the board would manage that potential conflict, even role-playing so that when a real conflict arises the board will be ready to handle it effortlessly.
The Typical Conflict of Interest Policy.
A conflict of interest policy should both require those with a conflict (or who think they may have a conflict) to disclose in writing and in detail the conflict/potential conflict, and, further prohibit interested board members from voting on any matter in which there is a conflict. Beyond including those two basic directives, each nonprofit needs to determine how the board will manage the conflict. Keep in mind that the IRS Form 990 asks not only about whether the nonprofit has a written conflict of interest policy, but also about the process that the nonprofit uses to manage conflicts, as well as how the nonprofit determines whether board members have a conflict of interest.
The following ideas have been formulated by experts in the field:
- Minutes of board meetings should reflect when a board member discloses that s/he has a conflict of interests and how the conflict was managed, that there was a discussion on the matter without the board member in the room, and that a vote was taken but that the “interested” board member abstained (board members with a conflict are “interested” – board members without a conflict are “disinterested”).
- Many nonprofits circulate a questionnaire regularly to determine whether any board member (or staff member) has a conflict of interest. Typically, the questionnaire asks board and staff members to disclose existing conflicts and reminds them to disclose any that may arise in the future.
- A written Conflicts of Interest Policy should be adopted and included in the records of the entity and handed out to any new Board member or staff.
- The procedure should be carefully followed and any violations dealt with quickly and fairly. Removal of a person who is in a conflict from the Board or staff should be accomplished if the conflict cannot be otherwise resolved.
Conflicts that are not managed can result in significant penalties to the person who benefits and to the organization, called "intermediate sanctions." (See IRS information on excess benefit transactions and inurement /private benefit that can result in penalties called imediate sanctions.)
This is not a casual requirement but essential not only to avoid tax ramifications but to maintain the degree of integrity and efficiency that donors and other members of the nonprofit will normally insist upon.
As one client put it to me, “I can always start a for profit entity that can do pretty much what I want. If I want the tax benefit of non-profit status, it’s a different game. That’s only fair. I have to abide by the restrictions. I get that