What Directors Need to Know About the Duty of Loyalty

By Frank DeVito

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If you work with a faith-based nonprofit, serve on a board of directors, or are thinking of joining a board, you have likely heard that directors have fiduciary duties. These duties (typically the duties of care, loyalty, and obedience) bind directors to uphold certain standards of conduct in their service to the nonprofit organization. The duties typically come from state law: while each state’s law may vary a bit, directors on the board of any nonprofit in the United States will be bound to some version of these fiduciary duties.

This resource will introduce you to the duty of loyalty. To learn more about the duty of care, click here. And to learn more about the duty of obedience, check out Napa Legal’s resource here.

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What is the duty of loyalty?

The duty of loyalty is essentially a requirement that board members put the interests and well-being of the nonprofit organization above their own personal or business interests.¹ When a board member makes a decision, the duty of loyalty requires him to consider what is in the best interests of the organization, not what is in the best interests of the director, his career, his family, or his business.  

While the duty of loyalty may sound obvious, there is an important reason for it: most directors of nonprofit organizations also lead, own, or are otherwise involved in for-profit business endeavors. It is quite common that a director is involved in a for-profit business and that it might make sense for the nonprofit organization to conduct business with that business entity. For example, if an organization is hosting a gala, the organization might want to have the dinner catered by a catering company owned by a director. Or an organization may require the services of an accountant, and a director might lead an accounting firm. In these situations, there is a conflict of interest. Conflict transactions generally are not strictly forbidden (though state laws vary), but there are many precautions that the organization must take when entering into a conflict transaction. For more on common mistakes regarding conflicts of interest, check out Napa Legal’s resource on the topic here.

So how does the duty of loyalty come into play when there is a potential conflict transaction? The duty requires the conflicted director (who is both a board member and has an interest in the for-profit company) to put the interests of the nonprofit organization, not the for-profit business, first. At a basic level, this requires making sure that the business relationship benefits the nonprofit organization and does not excessively benefit the for-profit organization.  

There are several steps that a nonprofit organization in this situation must take (such as getting quotes from other companies to make sure it is getting a good deal, ensuring that the price is not above fair-market value, and excluding the conflicted director from discussions and votes concerning entering into the conflicted transaction). But beyond these particular compliance steps, all directors need to be fully aware that they may never use their position as a director in a way that the nonprofit organization is giving an unfair benefit to the director, his family, or any business that he has an interest in.

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The Corporate Opportunity Doctrine

A discussion of the duty of loyalty should include at least a brief introduction to the corporate opportunity doctrine, which states that someone with fiduciary duties to an organization may not use business opportunities that belong to the organization for his own personal benefit.  

For example, if you are a director of the organization and, in your capacity as a director, you meet someone who is a potential donor to the organization, you are prohibited from instead encouraging that person to donate to another organization with which you are affiliated.  

Or if someone applies for a job at the nonprofit, you cannot contact that person and instead try to hire her as an employee of your for-profit company.  

In both cases, it can be acceptable to make the potential donor or job applicant aware of other opportunities if they are not interested in or a good fit for the opportunity with the nonprofit organization. But it is impermissible and a breach of the duty of loyalty to intentionally divert an opportunity from the nonprofit organization to any other opportunity in which you have an interest.

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Practical Next Steps

So what steps can you take to make sure that you are in compliance with the duty of loyalty as a director? While this list is not exhaustive, you can start by asking yourself these questions:

• Am I ever using my position as a director of the nonprofit organization to benefit myself personally or professionally?

• Am I ever putting the interests of myself, my family, or any business in which I am involved above the interests of the nonprofit organization?

• Do I disclose all potential conflicts of interest to the nonprofit organization?

• If I have a conflict of interest, am I making sure that I am excluded from any board discussions or actions involving the conflicted transaction?

• Am I careful to never divert an opportunity that arises as a director (such as a connection with a potential donor) to another opportunity or organization with which I am involved?

• Am I confident that all the actions I take as a director are in the best interests of the nonprofit organization?

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¹ What Are the Legal Duties of Nonprofit Board Members? BoardSource, https://boardsource.org/resources/legal-duties-nonprofit-board-members/.

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