What is a nonprofit conflict of interest and how can a policy help?

When a member of a board of directors assumes office, the law requires that the best interest of the nonprofit prevail over the director’s personal or business interests.

A conflict of interest most commonly arises when a person in a position of authority over an organization (like a board member or officer) could benefit financially from a decision he or she makes in his or her role as a board member of the nonprofit. Conflicts of interest can arise in many situations, including leasing property or buying services from a board member.

Nonprofits should adopt policies and procedures to ensure that those with decision-making power in the organization do not take actions that could benefit themselves, their families, or their business interests.

Conflicts exist. It matters how these conflicts are handled.

If conflicts are handled improperly, there can be legal problems and public perception consequences. But, in other cases, if a potential conflict is handled appropriately, it could result in a beneficial arrangement for the nonprofit.

For example, a board member who owns a catering company may offer reduced fees for the nonprofit’s annual dinner. Or, a board member who owns a building may reduce the rent for the nonprofit. Maybe this relationship would be helpful because it could offer reduced expenses for the organization. Committed board members want the organization to thrive, and may go to great lengths to do the job excellently.

The key question should be: What is in the best interest of the nonprofit?

Different states set out how potential conflicts of interest are to be handled. The Texas business code, for example, describes the circumstances in which an interested director or officer must

• • • Identify a potential conflict of interest
    • Disclose material facts of the interest or relationship, and then
    • Participate (or not) in the decision involving the topic in question.

Many nonprofits supplement state law with a comprehensive conflict of interest policy.

What is Allowed

In many states, the following are allowed. Check with your secretary of state or a lawyer who specializes in nonprofits for state-specific requirements.

• • • Reasonable compensation for services permitted.  A nonprofit may pay reasonable compensation to a director for services the director provides on behalf of the nonprofit. The key qualification is “reasonable,” which will be determined by the IRS, the Attorney General, donors, and the public on the basis of all the facts and circumstances of the situation.
    • Interested director transactions may be permitted so long as certain steps are taken. Texas law permits transactions with directors under certain circumstances. The three points with regard to an interested director transaction are:

• • • • • • Ensure that the transaction is fair to the nonprofit; and
          • Disclose material facts;
          • Document the decision-making process.

The material facts of the director’s interest in the transaction should be disclosed to the board before a vote on the transaction, and a majority of disinterested directors should approve the transaction in good faith and with ordinary care.  A transaction may be approved only if it is fair to the nonprofit when it is authorized.
Any transaction with an interested director should be carefully documented in the minutes of a meeting at which the transaction is considered.

Prohibited Actions – No Private Inurement

In most states, the following are not allowed. Check with your secretary of state or a lawyer who specializes in nonprofits for state-specific requirements. Each state law is specific. In Texas, check Business Organization Code Section 22.

• • • No financial loans.  There is an absolute prohibition on paying dividends or lending the money of a nonprofit to a director. Directors who allow the making of a loan to a co-director will be personally liable for the full amount of the loan until it is repaid.
    • No private inurement. There is also an absolute prohibition against “private inurement.”
      • In order for an organization to be recognized as a public charity by the IRS, no part of the net earnings of the organization may inure to the benefit of a private individual.
      • Private benefits may occur when the nonprofit pays more for goods and services than they are worth.
      • Violations of this restriction may result in severe penalties and substantial legal problems for the nonprofit and directors approving the transaction. Pay attention!
    • No excessive compensation (private inurement). An organization cannot pay excessive compensation. It is a major problem if the money that was raised from the general public is used for private benefit (like excessive compensation to a staff member). The board and an independent body must make sure that it is paying only reasonable compensation for services rendered.

Tips to handle conflicts of interest

There is always a potential for conflict of interest in any situation. What matters is how the nonprofit handles it. Some ideas:

• • • Implement a conflict of interest policy that is signed by all board members annually. The statement can be a simple declaration or require detailed information about the board members’ financial interests.
    • Bids. If major purchases (for either goods or services) are involved, obtain competitive written bids to ensure that prices and product are comparable if a board member stands to benefit (financially) from a particular decision. A board member who owns a catering company, for example, can propose having her firm provide services for the nonprofit’s annual dinner. Before making any decision, the staff may invite other companies to submit proposals. And, the board member who is proposing her services would not be a part of the discussion or vote on the matter. The board will fully document, in minutes, how the decision was made.
    • Ask, Discuss, and Record. Before major votes, have the board chair ask about potential conflicts of interest. Document this in the minutes and set out how the conflict was handled.

How can our nonprofit get a conflict of interest policy? Are there sample conflict of interest policies?

The IRS offers a sample conflict of interest policy for hospitals here. We recommend that you contact an attorney in your state who has experience with the nonprofit, tax-exempt sector to help with your policy.

This is different from “Can the Executive Director Serve on the Board?” The Executive Director is generally the key staff person that implements the work of the nonprofit.