It’s not always clear where responsibilities — and liabilities — lie when first starting a nonprofit. As you look into risk management, you may identify some nonprofit insurance policies you need right away and some that can wait until your nonprofit expands. So where does Directors and Officers Insurance enter the picture?
The short answer: you need D&O when your nonprofit adds a board of directors.
The long answer has to do with when you decide to turn an unincorporated nonprofit association into a nonprofit corporation. After all, having a board of directors is a legal requirement for this change of status. To understand why a nonprofit needs D&O Insurance when it reaches this step, let’s first take a look at what incorporation means and how it affects your nonprofit’s liability.
How Liability Changes When You Incorporate a Nonprofit
A nonprofit association can be something as simple as a group of friends pursuing a common charitable cause. These nonprofits are called "unincorporated nonprofit associations " — small groups with limited revenues that can file for tax-exempt status.
In terms of liability, though, being unincorporated means individual members can be held financially responsible for the group’s actions. So let’s say Tom, Sally, and Jane’s unincorporated association holds a fundraiser and a donor is injured at the event. The donor only caught Tom’s name, so they go after his personal assets in order to pay for their medical expenses.
Incorporating a nonprofit serves as a way to limit this kind of liability. By becoming a corporate entity, the nonprofit assumes most liabilities for actions taken by its members. So if Tom’s nonprofit were incorporated, his personal assets wouldn’t be at stake if the NPO were sued.
But there’s a slight catch. To become incorporated, a nonprofit must have a board of directors that agrees to…
- Run the association according to its bylaws.
- Fulfill basic duties and exercise reasonable care when making decisions for the organization.
- Assume certain responsibilities — and certain liabilities — that other members of the nonprofit don’t have to worry about.
This is where Directors and Officers Insurance can help. (Related reading: "Do I Need D&O Insurance for My Nonprofit? (Hint:Yes) .")
D&O Insurance Protects a Nonprofit’s Board Members
If incorporating a NPO shields the board of directors — as well as officers, trustees, and other members — from some personal liability, why does the nonprofit need D&O Insurance? The answer is in the question: incorporating only shields members from some personal liability. There are still plenty of ways board members can be personally vulnerable to lawsuits. After all, board members take on responsibilities that affect the entire organization.
Directors and Officers Insurance can help pay for legal expenses when a board member is sued over their decisions or their unethical behavior, such as…
- Personally guaranteeing a bank loan or business debt on which the nonprofit defaults.
- Failing to ensure that the nonprofit files necessary tax returns.
- Misusing nonprofit funds.
- Discriminatory hiring decisions.
D&O can step in whether or not the allegations are true, which gives your board members a chance to mount a legal defense. (Read more about the coverage in "What Should Your Directors and Officers Policy Cover?") Without the coverage, directors and officers must dip into their personal assets to deal with these lawsuits.
When creating a board of directors, D&O Insurance can help you attract talented candidates. Board members want to know that they’re not putting their personal assets on the line to help run an organization, even if they strongly believe in the cause. For more on that topic, check out the article "Why Your Board Might Demand You Carry D&O Insurance."