Avoiding Conflicts of Interest on the Board of Directors

Tucker Arensberg, P.C.
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Tucker Arensberg, P.C.

For profit and non profit corporations are governed to benefit a corporation and its shareholders or, from the non profit perspective, its charitable purpose/members. Conflicts of interest present significant ethical hurdles for any individual sitting on the board of directors (“board”) of a for profit or non profit corporation and may violate a director’s fiduciary duties to the corporation. Conflicts of interest may also undermine the credibility of an organization or divert benefits solely to benefit an individual serving on the board rather than the corporation. Prior to onboarding a director, the corporation should have certain procedures and policies in place to avoid any conflicts of interest.

New directors or long time serving directors may encounter various forms of conflicts. Some of these conflicts may not be apparent (even to long time serving directors) and may exist under circumstances where a director is using his or her best intentions. A few examples of conflicts of interest for a director on a corporate board are:

  • Adjusting his or her compensation or benefits
  • Being involved in a self dealing circumstance, insider trading, or the misappropriation of corporate assets or opportunities
  • Being involved with a competitor
  • Accepting gifts or favors from vendors
  • Being implicated in an interest adverse to the corporation

A few additional examples of conflicts of interest for a director on a non profit board are:

  • Receiving high/excessive salaries as founders or family centric board members
  • Creating expenses that do not correlate with the organization’s charitable purpose
  • Purchasing assets that only benefit founders or family centric boards
  • Entering into non-market contracts with third parties or family members that do not benefit the non profit organization

In order to identify, prevent or mitigate certain conflicts for new directors or for long time serving directors, every corporation should develop a conflicts of interest policy. The policy should provide guidance to each director to use good judgement, comply with any laws, if applicable, and comply with various stakeholders’ expectations (whether that may be shareholders, regulators, or donors).

The policy should also include various disclosure methods/procedures. These methods may come in the form of annual disclosure forms/questionnaires, providing written disclosure to the board upon entering into any transaction or arrangement, and/or providing written disclosure to the board anytime a conflict is identified. It is important that upon any disclosure that (i) the board obtains all material facts related to the conflict, (ii) the interested director provides any additional information requested from the board, and (iii) if required, the board may need to obtain third party consultants or legal counsel and accounting professionals to advise on the identified conflict. Providing disclosure will properly allow the corporation to manage the conflict and to provide additional protections and procedures to prevent any violation of an interested director’s fiduciary duties of loyalty or care. 

Additionally, the board should take the appropriate steps to document the conflict in the form of board minutes. Furthermore, if the conflict is a corporate opportunity, arrangement, or transaction being undertaken by an interested director, the board should deliberate and vote on the matter without the participation of the interested director. Documenting the board’s procedure will assure that the uninterested directors are following the conflicts of interest policy, and will provide evidence to any outside stakeholder that the directors were reasonable in approving any interested transaction.

Lastly, every corporation’s conflicts of interest policy should be revised regularly and reviewed to determine whether or not it is being enforced and whether or not it addresses the needs of the corporation.

Special Considerations for Non Profits

Non profit boards should implement a conflicts of interest policy out of necessity originating from their tax exempt status. A conflict or excessive benefit provided to a director may create a situation where the Internal Revenue Service (“IRS”) will audit the operations and financials of the non profit organization. Furthermore, IRS Form 990 (an annual filing for non profit organizations) inquires (i) whether the non profit organization has a conflicts of interest policy, (ii) whether or not the non profit organization observes an annual disclosure of conflicts, and (iii) whether the policy is consistently enforced. Any identified conflict, especially those conflicts providing an excess benefit to an interested director, must be reported in Form 990. In the event that a non profit organization is audited, a lack of transparency or enforcement of a conflicts of interest policy may lead to a situation where a non profit organization’s tax exempt status may be revoked.

Furthermore, the IRS may also enforce that any director interested transaction be unwound and that the excess benefit provided to an interested director be taxed at a 25% to 200% excise tax rate.     

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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