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A lawsuit is something nobody wishes to face. For nonprofits, the legal landscape for personal liability is even more complex than for most businesses. Members of a board of directors or founders of nonprofit organizations may not be entitled to the same protections from personal liability that other business executives enjoy. It is important to understand how this liability works and consult with legal counsel for specifics.

The Question of Incorporation

One of the primary facets of personal liability is whether or not the nonprofit is incorporated. Incorporated status automatically protects executives, directors, and founders from personal liability. A lawsuit may be leveled against the nonprofit itself for various accidents, injuries, or businesses losses, but individuals are generally protected – with a few exceptions. This is one major reason for a nonprofit to consider incorporating to protect its members.

If the nonprofit is incorporated, any judgments against the organization become debts of the nonprofit. If the nonprofit is unincorporated, then a payment for a judgment could be sought from the directors’ own pockets. This could potentially put personal assets, such as savings accounts and even homes and property, at risk of being liquidated to settle the debt. There is a risk of bankruptcy. These risks have deterred many individuals, especially those with large assets, from serving on boards of directors of unincorporated nonprofits. The good news is that the number of individuals actually sued in these situations is quite small. The choice often comes down to whether the individuals or the nonprofit itself is in a better position to the pay the judgment.

Using Waivers as Protection

If incorporation is not an option for the nonprofit, it may wish to take legal steps to protect itself and its members from liability. The best way to do this is through liability waivers. A liability waiver may be required of volunteers to prevent them from suing the nonprofit for a work-related injury. The waiver may also be presented to those interacting with the nonprofit or using its services to prevent professional liability claims.

Waivers often cannot protect against every possible liability. They also run the risk of alienating or deterring potential volunteers and customers, but they can often protect the nonprofit form the most likely and most expensive liabilities.

Using Insurance as Protection

Another form of protection that should be sought whether the nonprofit is incorporated or not is liability insurance. Insurance can provide protection to both the nonprofit and its directors and founders, because it is easier to claim money from insurance than from an individual’s or organization’s own pocket. While this adds to the nonprofit’s monthly expenses, it is an extremely important protection.

Insurance is effective because of the fact that most lawsuits end in settlement. Insurance represents an easy and quick payout whereas targeting an individual will likely result in a long and slow collections process. Even if personal liability is possible and even if the judgment could exceed insurance amounts, a settlement often will not. If nothing else, the insurance will cover the major share of costs, leaving individuals and the corporation with less worry.

Most organizations will have general insurance. Depending on risk, it may be worthwhile to purchase specific liability insurance in addition to general insurance to ensure full coverage.

Exceptions to Personal Liability

Even if every possible protection is in place, there are certain situations that will leave directors or founders personally liable. These are often very case-specific and are based on the intentional individual wrongdoing of the person involved.

There are three major personal liability concerns that will open a person up to a lawsuit even if they have standard protections:

  • The person directly or intentionally injures someone.
  • The person intentionally commits a crime, does something fraudulent or otherwise illegal, and      that act directly results in harm and loss to another person or the organization itself.
  • The person co-mingles personal funds and nonprofit funds. For example, depositing their own money in the nonprofit account, having a joint account, or allowing an account to be used for both their personal expenses and the nonprofit’s.

Any money in a joint account could be used for liability debts even if the major share of it is personal money.

The Importance of State Laws

Some states offer special protections to nonprofits, directors, founders, and volunteers. These laws give such individuals extra liability protection, even if their nonprofit is unincorporated and even if they do not have basic protections such as waivers or insurance. While organizations should not rely solely on these special state laws for protection, they can help, and it is always a good idea to be aware of them.

Special Considerations for Unpaid Taxes

While most nonprofits are tax exempt in some categories, they may still have some form of tax obligations. This category of liability deserves special mention because it is both often overlooked and the most common type of liability to actually affect directors.

This tax liability often results from a death spiral. A nonprofit may find itself financially strapped and unable to pay taxes. The nonprofit may ultimately fail and leave those taxes unpaid with no money remaining to pay them. The IRS has the authority in this situation to pursue collections against board members and founders. Most legal protections that prevent board members from suffering liability does not protect them against the IRS. Even insurance is unlikely to cover tax liability.

Armed with Knowledge

The best defense any nonprofit director or founder has is knowledge. There is risk involved in becoming the director or founder of an unincorporated nonprofit, but this risk can be minimalized with the right understanding of liability.

A skilled director or board will ensure the right protections are in place for their valuable members. They will also understand how to prevent a liability situation from occurring in the first place. It may not be possible to prevent every situation, but most serious liability situations are the result of mistakes or oversights that can be avoided with the right knowledge and planning.

It is important for nonprofits, especially smaller, more vulnerable organizations, to stay on top of liability issues and protections. These protections are not only vital to the organization’s survival but also vital to the retention of top talent. Skilled directors and managers will have an understanding of liability, and they may be unwilling to serve an organization that manages its liability poorly. The risk of personal liability is a poor reason to lose good directors, and it is one that every nonprofit can avoid. Whether the nonprofit is incorporated or unincorporated, large or small, every organization can and should take steps to protect itself and its leaders from liability.

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