NORTH CAROLINA LAW REVIEW Volume 90 Article 2 Number 6 North Carolina Issue 9-1-2012 Duties of Nonprofit orC porate Directors - Emphasizing Oversight Responsibilities Thomas Lee Hazen Lisa Love Hazen Follow this and additional works at: http://scholarship.law.unc.edu/nclr Part of the Law Commons Recommended Citation Thomas L. Hazen & Lisa L. Hazen, Duties of Nonprofit Corporate Directors - Emphasizing Oversight Responsibilities, 90 N.C. L. Rev. 1845 (2012). Available at: http://scholarship.law.unc.edu/nclr/vol90/iss6/2 This Article is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina Law Review by an authorized administrator of Carolina Law Scholarship Repository. For more information, please contact [email protected]. DUTIES OF NONPROFIT CORPORATE DIRECTORS-EMPHASIZING OVERSIGHT RESPONSIBILITIES' THOMAS LEE HAZEN*' & LISA LOVE HAZEN*** The law on nonprofit directors' obligations is sparse. Nevertheless, in recent years nonprofit directors have faced increased scrutiny. This Article explores this increased scrutiny and sheds light on the development of North Carolinanonprofit law as it pertains to directors' duties.' North Carolinaimposes stringent duties on nonprofit directors including the duty of overseeing the nonprofit's operations. However, following the pattern in most states, there are limited avenues for holding directors accountable. INTRO D U CTIO N ................................................................................................. 1846 I. OVERVIEW OF NONPROFIT ORGANIZATIONS ................................... 1848 A. Role of Nonprofit Governing Boards ......................................... 1849 B. Regulation of Nonprofits .............................................................. 1851 II. FEDERAL TAX EXEMPTION AND RESULTING IMPACT ON BOARD D UTIE S ...................................................................................................1853 III. B EST PRA CTICES ................................................................................... 1857 IV. NONPROFIT DIRECTORS' DUTIES UNDER STATE LAW .................... 1861 A. Duties of Care, Loyalty, and Good Faith.................................... 1861 B. D uty of O bedience ........................................................................ 1863 V. NORTH CAROLINA FORMULATIONS OF NONPROFIT DIRECTORS' D U TIE S ................................................................................................... 1867 A. ParallelsBetween North Carolina'sBusiness Corporationand Nonprofit Law ................................................. 1867 B. History of the North CarolinaNonprofit CorporationAct ....... 1868 * © 2012 Thomas Lee Hazen and Lisa Love Hazen. ** Thomas Lee Hazen is the Cary C. Boshamer Distinguished Professor of Law at the University of North Carolina at Chapel Hill. *** Lisa Love Hazen has served on a number of nonprofit and charitable boards of directors. 1. This Article focuses on nonprofits in North Carolina. For a national perspective, see generally Thomas Lee Hazen & Lisa Love Hazen, Punctilios and Nonprofit Corporate Governance-A Comprehensive Look at Nonprofit Directors' Fiduciary Duties, 14 U. PA. J. Bus. L. 347 (2012). Some portions of this Article are adapted from the aforementioned Article. 1846 NORTH CAROLINA LAW REVIEW [Vol. 90 C. Comparison of the North CarolinaNonprofit CorporationAct and the Revised Model Nonprofit Corporation A ct ............................................................................ 1872 VI. LIMITED REMEDIES FOR DIRECTOR MISCONDUCT .......................... 1875 A. Qualified Immunity (and Insurance) .......................................... 1875 B. D irector R emoval .......................................................................... 1878 C. Actions by the Attorney General.................................................. 1879 D . Derivative Suits .............................................................................. 1880 E. Is Best Practices Our Best Hope? ................................................ 1881 C O N CLU SIO N ..................................................................................................... 1883 INTRODUCTION There is scant literature on nonprofit directors' duties under North Carolina law. Nationally, there has been a rethinking of nonprofit best practices in the wake of corporate governance reforms in the for-profit sector. The IRS in 2008 enhanced its scrutiny of nonprofits with a focus on governance structure.2 North Carolina law relating to nonprofit directors' duties is relatively new but has some interesting history. This Article explores the obligations of nonprofit directors in North Carolina in light of these developments and the unique history of the North Carolina statute governing nonprofits. Ordinarily, increased responsibilities result in a comparable increase in accountability. Increasing nonprofit directors' liability, however, would likely deter many conscientious candidates from considering board service. The current balance in the North Carolina nonprofit statute makes sense. If nonprofit directors do not follow the heightened oversight guidelines suggested here, there will be increased need for the Attorney General to provide oversight. There have been many highly publicized scandals involving nonprofit corporations. 3 These generally involve excessive compensation to executives 2. See infra Part II (discussing the amendments to Form 990). 3. See Roger Colinvaux, Charity in the 21st Century: Trending Toward Decay, 11 FLA. TAX REV. 1, 20-38 (2011) (highlighting multiple past scandals at nonprofit corporations); Deborah A. DeMott, Self-Dealing Transactionsin Nonprofit Corporations, 59 BROOK. L. REV. 131, 133 (1993) (describing self-dealing by directors of United Way and the San Diego National Sports Training Foundation); Developments in the Law- Nonprofit Corporations,105 HARV. L. REV. 1578, 1591 n.5 (1992) (noting Jim Bakker's PTL ministry scandal); Harvey J. Goldschmid, The FiduciaryDuties of Nonprofit Directors and Officers: Paradoxes, Problems, and Proposed Reforms, 23 J. CORP. L. 631, 633-35 (1998) (discussing United Way and Adelphi University's problems with excessive executive compensation); Rachel Penski, Note, The Case of CEO Richard Grasso and the NYSE: Proposals for Controlling Executive Compensation at Public Nonprofit Corporations,58 VAND. L. REV. 339, 340-41 (2005) (highlighting the large compensation package for former New York Stock Exchange CEO when the Exchange was a nonprofit corporation). See generally SAMUEL P. KING & RANDALL W. ROTH, BROKEN TRUST- 2012] NONPROFIT CORPORATE DIRECTORS 1847 or other insiders4 and, in the most extreme cases, outright embezzlement. North Carolina has not been immune from high levels of nonprofit executive compensation.5 Typically in these extreme situations, the wrongdoing is allowed to occur because the nonprofit's board members were not adhering to proper oversight practices. These abuses are not limited to large-scale, nationally-known nonprofit governance failures.6 Happily, there are also some publicized examples of North Carolina nonprofit boards doing what they are supposed to do.7 GREED, MISMANAGEMENT & POLITICAL MANIPULATION AT AMERICA'S LARGEST CHARITABLE TRUST (2006) (chronicling mismanagement and corruption of the Bishop estate that established a charitable trust); James J. Fishman, Improving Charitable Accountability, 62 MD. L. REV. 218, 219 n.1 (2003) (noting several high-profile nonprofit scandals that have helped fuel reform efforts). 4. See, e.g., Vacco v. Diamandopoulos, 715 N.Y.S.2d 269, 270-71 (N.Y. Sup. Ct. 1998) (upholding Attorney General's complaint seeking to hold directors accountable for excessive compensation and mismanagement of university's assets; denying defendants' claim for advanced indemnification); see also People ex rel. Spitzer v. Grasso, 816 N.Y.S.2d 863, 863 (N.Y. Sup. Ct. 2006) (denying defendant New York Stock Exchange CEO's motion to dismiss challenges to executive compensation as excessive), rev'd, People v. Grasso, 862 N.Y.S.2d 828, 828 (N.Y. 2008) (dismissing claims). See generally Milton Cerny et al., New Scrutiny of College and University Executive Compensation and Unrelated Business Activity, 37 J.C. & U.L. 93 (2010) (discussing increased IRS scrutiny of compensation). For an egregious example in North Carolina, see Julie Rose, Multiple Execs At Small Charlotte Nonprofit Earning $300K+, WFAE 97 NEWS (July 15, 2011), http://wfae.org/wfae/1_87_115.cfm?action=display&id=7570 (describing high compensation paid to board members of what appears to be a family nonprofit). 5. See, e.g., 9 Investigates CEO Pay for Mecklenburg Nonprofits, WSOCTV.COM (Mar. 9, 2009), http://www.wsoctv.com/news/18890104/detail.html (detailing the high salaries of United Way and YMCA top executives). 6. A poignant example of board failure occurred with respect to the Five Rivers Community Development Corporation in South Carolina. See CMTY. ACTION PROGRAM LEGAL SERVS., CAPLAW GOVERNANCE SERIES, CASE 1: THE EXECUTIVE DIRECrOR'S ROLE VIS-A-VIS THE BOARD, http://www.caplaw.org/Case-Study-l-000.pdf.pdf (case study based on the demise of the Five Rivers Community Development Corporation); David Wren, Board Not Consulted on Wages, SUN NEWS (Myrtle Beach), Dec. 10, 2006, http://www.myrtlebeachonline.com/2006/12/10/31990/board-not-consulted-on-wages.html; David Wren, Nonprofit Pay Rises Under Little Oversight, SUN NEWS (Myrtle Beach), Aug. 20, 2006,