Nonprofit Management Faces Liability Risks

John Trefry


September 1, 2014

In the United States, more than 2.3 million organizations operate as nonprofits, requiring at least as many board seats to be filled annually. This group of mostly tax-exempt organizations includes foundations, clubs, membership and service organizations, private educational institutions, performing arts groups, shelters, and food banks. The size and missions of these organizations are diverse, yet their management has one thing in common: liability risk.

Unfortunately, there is a knowledge gap between the extent of the risk nonprofits face and what they are doing to prepare for it, particularly when it comes to directors and officers (D&O) liability. For example, Travelers recently surveyed 250 nonprofit organizations and found that a large percentage of them are either unaware of or do not fully appreciate their management liability risks. More than two-thirds (69%) of the nonprofits that participated in the survey said they do not purchase D&O coverage. Further, more than 40% of respondents were unaware that directors' and officers' personal assets could be at risk in the event of a lawsuit against the organization.

That ignorance could come with a big price tag. If a nonprofit is sued, litigation costs could drain the organization's assets and leave board members responsible for footing the bill with their personal finances. Nonprofit leaders should understand the importance of D&O coverage to properly protect their personal  finances and reputations as well as those of the organization.

While nonprofit executives often think a lawsuit will not happen to them, industry statistics suggest otherwise. According to Towers Watson, an overwhelming 63% of nonprofit organizations reported a D&O claim in the past 10 years.

Legal fees and damages resulting from nonprofit director and officer claims can quickly drain limited organizational resources. Considering that a two-week jury trial can come with significant legal costs, it is a much more expensive proposition for nonprofits not to purchase D&O coverage.

It would also be a mistake for a nonprofit board member to assume that he or she is fully protected from such costs by federal and state volunteer immunity statutes. Such statutes generally do not apply to defense expenses or provide immunity to the organization, and they usually do not apply to all types of conduct, such as gross negligence.

The Travelers survey suggests that a significant percentage of nonprofits may not fully understand the various sources of potential litigation. More than a quarter of uninsured nonprofits have no concerns about potential liability for breach of fiduciary duty, misuse of funds, waste of the organization's assets, failure to carry out the organization's mission, wrongful employment actions, trademark/copyright infringement, personal injury, breach of contract or antitrust. Yet these are some of the most common types of D&O claims involving nonprofit organizations.

The assets of the organization and its leadership are not the only things at risk. Going uninsured can also have a significant impact on the quality of board members a nonprofit can attract. Top talent may forgo an opportunity to participate on a board if their personal assets are unprotected. Additionally, enduring a large lawsuit without the funds for proper defense and guidance can increase the chances of reputational damage. A properly insured nonprofit can continue to focus on its mission while the insurer manages complex litigation.

It is important that nonprofits understand their management liability risks and the insurance solutions available to address them. D&O liability insurance includes much-needed coverage for defense costs as well as settlements and judgments associated with demands and lawsuits against nonprofit organizations and their directors, officers, trustees, employees and volunteers for actual or alleged misconduct or mismanagement.

D&O is different from "occurrence-based" commercial general liability, business owner's liability and homeowners liability because it usually provides coverage on a "claims-made" basis that, subject to some exceptions, is generally designed to cover losses stemming from events other than bodily injury and property damage.

A costly liability issue can be extremely damaging to a nonprofit. But by making sure they are properly prepared, nonprofits can avoid trouble and continue to focus on serving their communities.
John Trefry is a directors and officers liability product manager with Travelers Bond & Financial Products.