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Nonprofit Basics: Designators, Members, Directors, Officers: The Who’s Who of Nonprofit Governance

May 31, 2022 Podcast
EO Radio Show

Welcome to EO Radio Show, Your Nonprofit Legal Resource, brought to you by the Exempt Organizations Group at Farella Braun + Martel. My name is Cynthia Rowland and I'm a partner at Farella. I'm a business and tax lawyer with more than 30 years of experience advising clients on nonprofit and charity law.

This Nonprofit Basics episode covers some of the roles that people play in the governance of a nonprofit corporation. We're focused here mostly on nonprofit corporations, although nonprofits can be formed as charitable trusts. Let's go over the nonprofit corporation governance positions first and then we'll circle back to how these concepts of governance apply in the trust structure.

Unlike regular corporations, where the shareholders call the shots, in a nonprofit corporation there are no shareholders; no owners who get to appoint the directors. Instead, the ultimate decisions about who serves on the governing body are made either by members or in some cases by designators or by the directors themselves. The latter structure being what is referred to as a self-perpetuating board.

So when thinking about the governance structure for a new nonprofit, one of the first questions is who will choose the successor directors and control the organization. Sometimes the organization is best governed by having one or more persons who have the responsibility just to name the directors. We call those roles either designator entities, or in some cases, we call them members.

The difference depends on the rights that the designating person should have, needs to have, or wants to have. When it is important for individuals to have the right to be involved in certain key organizational decision making, such as liquidation or termination of the organization, sale of all or substantially all of its assets, merger, or similar key decisions, it is often in the interest of the organization to actually have a voting member class. In most states, the nonprofit corporation law gives these kinds of members statutory rights that cannot easily be modified without their consent.

Sometimes these member rights can become a real impediment though to making changes in the governance that might be needed. For example, member meetings are required and there are specific rules that cover notice of the meetings, quorum requirements, proxy voting, and even specific notice requirements that must be included in a member meeting notice.

So you can see that managing a membership nonprofit corporation requires a lot of attention to the details of obtaining member consent and approval to certain actions. I generally recommend avoiding a membership structure unless it's absolutely essential in order to attract the supporters, whether financial or volunteer, and attracting those individuals requires voting member benefits. That's rarely a fundamental need for a charity or a foundation.

A somewhat similar structure that's much easier to manage than a formal voting membership, but that has some of the benefits of that membership structure, is to use a designator feature instead. A designator can be built into the bylaws to include a corporate entity such as a parent nonprofit organization or founding business enterprise. A designator can also be the founding individual who is both founding and funding the new charity. This individual may want only the right to name successor directors, but doesn't necessarily want to be involved in other key decisions or otherwise have the statutory member rights I mentioned a few minutes ago. So sometimes the designator feature is a really handy tool.

So moving on to the role of the director. A director of a nonprofit corporation is an extremely important role. It's important to keep in mind that directors do not act on their own as individuals. The board of directors, collectively as a group, has the fiduciary responsibility to oversee all activities of the corporation. It's worth repeating the concept here. An individual director has no authority simply as a director to take any action or cause any action to be taken by the organization. Directors only act by a quorum with a majority vote to take action.

As an aside, sometimes the bylaws even require a supermajority or unanimous vote of the directors to do certain things or in certain circumstances.

Another really important concept for director action is that each director has only one vote on any matter that is subject to the vote of the board. The right to vote as a director is a personal right; directors can't act by proxy. For his or her vote to count, the director must cast it himself or herself.

Two other common questions come up when new nonprofits are formed. How many directors should there be? And do the executive officers have to be directors? In many states the minimum number is one. But usually, it's best to have at least two and three as the practical minimum. In many small startup organizations, since the directors will also serve as executive officers, the minimum is two for reasons I'll explain in a minute, but three is a great number of directors to start with. And unless there are extenuating circumstances that require a big board at the outset, it's often most practical to keep the size at startup to not more than five so that these initial decisions and actions can be taken relatively quickly and easily. The bylaws can allow any number of directors and the practical upper limit is the capacity of the organizers to corral the votes of the directors when needed.

Remember, in general, the organization is going to need majority vote of a quorum of the directors to take action at a meeting or unanimous consent if the action is taken without a meeting. Voting rules are beyond the scope of this episode, so we'll get to those details in a later installment.

One of the most important decisions that a board of directors makes from time to time is the appointment of the executive officers, who can be, but they don't have to be, the directors. Nonprofit corporations must have a chief executive or president, a chief financial officer also known as a treasurer, and a corporate secretary. A common misconception is that these are officers of the board. There actually is no such thing as an officer of the board.

The officers elected by the board of directors are the executive officers of the corporation. They have statutory responsibilities that are spelled out in the corporate law of the state where the corporation is incorporated. These key executive offices are appointed and removed only by the board of directors acting as a board. In most states, the corporations law provides that the individual who serves as president can't at the same time also hold the office of secretary or the office of treasurer. The purpose of this rule is to ensure that there's a check and balance in the executive staff of the corporation.

Interestingly, Delaware law allows the same person to hold all three offices. Even though allowed, it is just really not a very good business practice. The better approach is to have at least two executive officers, if for no other reason than to make sure that if one of them isn't available to carry out a key function, there'll be a backup plan. The executive officers are the doers in the day-to-day life of the organization. The board delegates to them the authority to do all the things necessary to run the show.

So back to charitable trusts for a moment. As I mentioned in episode one, which discussed choice of form for a nonprofit, charities and foundations can be formed by a declaration of trust and they don't file articles of incorporation in any state. They don't typically have bylaws and they rarely appoint officers. A charitable trust is governed by one or more trustees. These trustees have fiduciary duties with respect to the charitable assets and the charitable activities. Trustees have all the authority that is given to them in the document, which is known as the declaration of trust.

Unlike entities formed as corporations, there aren't any default statutory provisions in the corporations code of the state where the trust is established. Instead, the trustees act in the manner that's provided in the declaration of trust document. Sometimes there's only one trustee and that trustee has the authority to act on his or her own to do all things that are necessary for the operation of the charity. That trustee can even be a trust fiduciary company, which carries out the trustee actions through the company's own employees. Oftentimes a charitable trust is governed by several trustees and it's important that the trust instrument or declaration of trust describes whether those trustees may act individually or whether they must act by majority agreement. Unlike directors of a nonprofit corporation, who by statute have to act by majority at a meeting or by unanimous written consent, there's considerable latitude for the trust instrument to provide that a trustee can have varying voting rights. For example, a declaration of trust may allow a particular trustee to have two votes and other trustees only one. Trustees can adopt bylaws, appoint officers, and act generally like a corporation, but they usually don't.

The trust form works really well for private family foundations, but it rarely is a good idea for a fundraising public charity with active operations.

An important side note here, sometimes the board members of a nonprofit corporation call themselves trustees, even though under corporate law they are actually directors. In that scenario, the legal structure is a corporate form, not a trust, and trustee is just a label for director.

So in wrap-up, the key roles to understand for the governance of a nonprofit corporation are those of voting member, director, and officer, all of which are defined by state corporation law. A trustee of a charitable trust essentially has the role of director and executive officer, unless the duties are otherwise limited in the declaration of trust. Take a look at the show notes for more resources and additional information.

Well, that's it for today, I'm Cynthia Rowland and you've been listening to EO Radio Show, Your Nonprofit Legal Resource, brought to you by the Exempt Organizations group at Farella Braun + Martel. If you have suggestions for topics you would like for us to discuss, please email [email protected]. Thank you for joining us. And until next time, make a difference.

Show Notes:

New York Attorney General Publication on Nonprofit Director Responsibilities 

Guidebook for Directors of Nonprofit Corporations, Third Edition

National Association of State Charity Officials Resources

Additional episodes can be found at EORadioShowByFarella.com

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