Directors of non-profit organizations generally take their responsibilities seriously. But directors of non-profits are motivated by fulfilling the mission, often while facing serious financial pressures.

All directors, including those of non-profits, are protected from lawsuits for breach of fiduciary duty in two ways. First, virtually all states have statutory limitations on the liability of non-profit directors, reflecting a policy of encouraging people to serve non-profit undertakings. Second, the so-called “business judgment rule” protects all directors (in both profit and non-profit companies) from liability for mismanagement provided the directors use reasonable judgment and do not self-deal.

Between these legal protections and contractual exonerations from liability typically \written into charter documents, directors rightfully have felt reasonably secure from litigation risk even as they guided their organizations along the narrow path of economic viability.

Enter the Third Federal Circuit Court of Appeals, reviewing the contentions of creditors claiming in two cases that the non-profit trustees/directors breached their duty by reason of imprudent management when on the verge of insolvency. (Creditors of bankrupt entities have the power to commence an adversary proceeding against the directors or trustees of any bankrupt company, including a non-profit, for breach of the fiduciary duty of care and loyalty, where the trustees/directors may have knowingly or carelessly expended monies and incurred indebtedness while the company was sinking financially.)

All such cases are highly fact-dependent. A company is insolvent when it is unable to pay its debts as due, or when its balance sheet is under water. In these recent cases, a 130 year old home for the elderly and a well-known women’s college each filed for bankruptcy, the trustees of each were sued, and the Circuit Court in each instance has allowed the cases to go forward (no final resolution as to liability yet).

Non-profit directors may be particularly susceptible to this kind of law suit; non-profits generally lack robust independent incomes streams. They are often dependent on donations and/or fundraising events (each of which may be quixotic given the general economy or other extrinsic factors).

No standard of how board members should act, beyond “prudently” and in the reasonable interest of creditors where insolvency seems imminent, can be generally stated, as facts and the alleged degree of grievous insensitivity to financial issues will vary wildly. We can say that boards should be particularly sensitive if endowment gives no adequate cushion, and if costs have run ahead of income over time. Attention to cash flow projections as well as the balance sheet is wise. Failure to collect receivables, undertaking major new products or services, granting high pay to management, and executive self-dealings could be significant indicators of liability where the non-profit has sunk into bankruptcy and the creditors are looking backwards in time to see “who is to blame.”

Yet another reason for non-profit boards to be formally educated in their technical fiduciary duties.