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5 Habits to Avoid Nonprofit Legal Disasters

November 23, 2016

In the world of nonprofit law, disaster scenarios are common. For example, since 2010, approximately 550,000 organizations have had their tax-exempt status revoked for failure to file the Form 990 (or 990-EZ, or 990-n, where appropriate) for 3 consecutive years. Similarly, many organizations are subjected to heavy fines for failure to report unrelated business income tax, for misclassifying employees as independent contractors, or for conveying improper benefits to directors or officers. 

However, most of these legal mishaps can be prevented (or at least mitigated) by building good organizational habits and taking simple precautionary measures. This article discusses five key practices that lay the groundwork for any well-run nonprofit. Organizations that build these good habits early rarely suffer legal setbacks that cannot be corrected with minimal time and cost.

Have a Business Plan

Many small businesses are run in an informal way, without much forethought about revenue sources or essential expenses. Nonprofits do not have this luxury. Funding is too scarce and the administrative burdens too severe for a nonprofit to thrive without a rigorous planning process. A nonprofit's business plan should include a fundraising plan (with a mix of donations, grants, and fee-for-service revenue that is tailored to your organization), a strategic plan (detailing how your organization will accomplish its mission), and a budget to pay for expenses and administrative help. The budget is particularly important, because skimping on necessary services such as insurance, accounting, legal and payroll help can lead to errors that cost a lot of money to fix later. 

Get Adequate Insurance

Legal setbacks can happen even to well-run nonprofits. Getting adequate insurance will ensure these setbacks don't have disastrous financial consequences. Directors & Officers ("D&O") insurance protects board members and officers from personal liability for alleged wrongdoing such as mismanagement and breach of fiduciary duties (including the legal defense costs of such allegations), and is essential for any organization. Organizations with more than 1 or 2 employees should also look into Employment Practices Liability (EPL) insurance, which protects the organization against allegations of wrongful termination, discrimination, harassment and other employment practices--the most frequent source of litigation for nonprofits. Lastly, organizations engaging in any type of complex business practice should consider Errors & Omissions (E&O) insurance. 

Keep Good Financial Records

An organization cannot function without good financial records (and failure to keep good records is usually the first step towards disaster). Good financial records are necessary to support the positions taken on the Form 990, to comply with restrictions on grants, and for the Board of Directors to fulfill its fiduciary duties. Nonprofit accounting raises unique and challenging issues that require the help of an expert, at least occasionally. Consider hiring an outsourced accountant to assist with your financial recordkeeping, and look into whether your organization should have an audit, review or compilation by a reputable CPA firm with nonprofit expertise.

Keep Good Board Meeting Minutes

Aside from the financial records, the Board meeting minutes tell the story of your organization more than any other document. In the event of any legal controversy, the minutes from your Board meetings will be closely examined to determine the facts. Unfortunately many nonprofits make the mistake of not including enough detail, or including too much detail in the Board meeting minutes. It can be difficult to strike the right balance. As a general rule, an organization should document the general gist of the discussion (there is no need to transcribe every statement made at a meeting), and include detail where necessary to protect the Board and document important transactions, such as when the Board exercises due diligence in business transactions or compensation decisions. 

Adopt and Follow the Essential Corporate Policies

Most nonprofits adopt the three corporate policies mentioned in the Form 990: the conflict of interest policy, whistleblower policy, and document retention and destruction policy. In addition, it is advisable to adopt a travel and expense reimbursement policy, a charitable gift acceptance policy, and an employee handbook. However, it's not enough to simply adopt these policies and file them away. An organization's directors, officers and employees must also know the terms of all its policies and take steps to implement the policy terms into daily practice. 

This blog was written by Academy for Nonprofit Excellence Instructor, Benjamin Takis.