Navigating Board Service Risk

29 Apr Navigating Board Service Risk

It is common for high-net-worth clients to offer their skills, leadership, and expertise to boards of nonprofits, professional organizations, or homeowners associations.  In many cases, clients assume director roles without properly assessing and planning to mitigate exposure to their personal assets.

This Risk Tip highlights the inherent personal risk of serving on a board and presents a concise summary of what areas must be assessed and planned for to effectively mitigate the exposure.

Claims that name directors along with the organization can be high in financial and reputational severity and assessing the exposure can be complicated. Clients can incur personal liability under numerous statutory provisions. Though corporations are established with the intent to protect directors and officers from personal liability, current regulations permit tort creditors to extend beyond the designated pool of assets and include the personal assets of directors, akin to vicarious liability.

Would not a director be protected behind the corporate veil of the organization?  The simple answer is “it depends.” Doesn’t the organization’s D&O insurance mitigate this risk for the client?  Unfortunately, exclusions, limitations, conditions, and varying endorsement requirements make answering this question challenging.  Take for example a small nonprofit organization that has exposure serving children or students.  There may be exclusion language for allegations or acts of sexual misconduct.  If there is coverage, there may be a separate sub limit from the main policy and excess limits.  In addition, there may be very specific conditions that the board must validate are being adhered to if coverage is going to extend.

When individuals serve on a board, they take on fiduciary duties of care and loyalty to act in good faith for the best interests of the organization. They can be held personally liable for failure to provide proper financial oversight, improper employment practices, as well as misrepresentation, fraud, and other gross negligence.  Accidental failure to adhere to organizational governance documents or laws are also common occurrences that could lead to personal liability exposure.

Skilled, highly qualified, and well-intended individuals are not immune from facing legal action arising from actions either taken or not taken that lead to harm. The legal doctrine of constructive knowledge may hold a director liable for facts or conditions that they “should” or “could” have known about with reasonable diligence or inquiry.

Thorough assessment and risk management planning must be done for each organization that a client serves on the board.  The review should be completed prior to stepping into the role and should include the client’s fitness and capacity for the role, financial due diligence on the organization, and review of insurance contracts, governance documents (important attention to the difference between “indemnifiable” and “non-indemnifiable” language), and employment practices procedures.  Should assessment reveal deficiencies in any of these areas, the client should pause and consider abstaining from service or verify that the area has been corrected before commencing service.