Nonprofit organizations often operate with lean staffing, significant volunteer involvement, and governing boards comprised of dedicated community members rather than professional risk managers. As a result, when allegations of fraud, misconduct, harassment, threats, financial irregularities, or governance failures arise, organizations can find themselves facing substantial legal and operational risks with limited internal resources to address them.
For attorneys advising nonprofit clients, effective risk management frequently begins long before a dispute results in litigation.
Investigate Early and Preserve Evidence
One of the most common mistakes nonprofit leaders make is treating a potentially serious issue as an internal personnel dispute or community disagreement rather than a legal and governance matter.
When allegations of financial misconduct, harassment, threats, embezzlement, self-dealing, or other wrongdoing arise, counsel should encourage clients to:
- Preserve relevant records and communications;
- Suspend routine document destruction practices;
- Identify witnesses and collect information promptly;
- Maintain confidentiality to the extent possible; and
- Conduct an appropriate internal or independent investigation.
Early fact gathering often determines whether a matter remains manageable or develops into a regulatory, employment, or litigation problem.
Use Available Resources
Many nonprofit boards are unaware of the resources available to assist them during a crisis.
Depending on the circumstances, counsel should consider directing clients to:
- Their insurance carrier and coverage counsel;
- Independent investigators;
- Employment counsel;
- Forensic accountants or auditors;
- Law enforcement agencies;
- Cybersecurity professionals;
- Risk management consultants; and
- The California Attorney General’s Registry of Charities and Fundraisers.
Engaging the appropriate professionals early can significantly reduce both legal exposure and reputational damage.
Build a Team of Trusted Advisors Before a Crisis Occurs
One of the most valuable investments a nonprofit can make is developing relationships with knowledgeable advisors before problems arise. Nonprofits routinely encounter a wide range of legal, financial, employment, governance, fundraising, regulatory, and operational issues, many of which involve specialized rules that differ significantly from those applicable to for-profit businesses.
Attorneys advising nonprofit clients should encourage boards and executive leadership to assemble a trusted team of professionals who understand the nonprofit sector and can provide guidance when issues emerge. At a minimum, that team should generally include:
- Business and nonprofit counsel familiar with governance, contracts, fundraising, and regulatory compliance;
- Employment counsel experienced with wage-and-hour issues, volunteer classification, workplace investigations, and employee relations;
- A certified public accountant with significant nonprofit experience, including tax-exempt organizations, charitable reporting requirements, and restricted-fund accounting;
- A trusted insurance broker who understands the nonprofit sector and can help evaluate risk exposures and available coverage.
Importantly, nonprofit accounting and tax compliance is its own area of specialization. Not every CPA who works with small businesses is familiar with the unique issues presented by tax-exempt entities, including Form 990 reporting, charitable contribution substantiation requirements, grant restrictions, unrelated business income, and state charitable registration obligations. Similarly, insurance needs often extend far beyond basic general liability coverage.
As organizations grow, they should periodically evaluate whether specialized coverage or consulting expertise is warranted. Depending on the organization’s activities, this may include:
- Workers’ compensation coverage and related workplace-safety guidance;
- Employment Practices Liability Insurance (EPLI) to address employee and volunteer-related claims;
- Cybersecurity consultants and cyber-liability insurance to address data breaches, ransomware attacks, and privacy concerns;
- Directors and Officers (D&O) coverage to protect board members and officers from claims arising out of governance decisions; and
- Specialty advisors for fundraising, event operations, regulatory compliance, or technology-related risks.
A recurring lesson for nonprofit boards is that problems are often less expensive to prevent than to cure. Organizations that establish relationships with qualified subject-matter experts before a crisis occurs are generally better positioned to identify risks early, respond appropriately, and fulfill their mission while minimizing legal and financial exposure.
Do Not Underestimate the Risk of Inaction
Nonprofit leaders often focus on the potential liability associated with taking action while giving insufficient attention to the risks of doing nothing.
Whether the concern involves suspected fraud, threats to staff or volunteers, conflicts of interest, or participant safety issues, boards should evaluate not only the consequences of intervention but also the foreseeable harm that could result from failing to act.
In many situations, a carefully documented decision made in good faith to protect people, organizational assets, and the nonprofit’s mission will be far easier to defend than a failure to respond to known risks.
Volunteers and Worker Classification Risks
Many nonprofits depend heavily on volunteers, but attorneys should regularly remind clients that labeling someone a “volunteer” does not automatically make it so.
Particularly where an individual:
- Performs regular operational functions;
- Is subject to substantial supervision and control;
- Receives compensation, stipends, housing, or significant benefits; or
- Performs work similar to that performed by paid personnel.
There may be a risk that the individual could later contend that they were actually an employee.
Misclassification claims can expose organizations to liability for unpaid wages, overtime, meal and rest break violations, payroll taxes, workers’ compensation issues, and related penalties. Attorneys should encourage periodic reviews of volunteer programs and ensure that volunteer roles are structured consistently with applicable state and federal law.
Strengthen Governance Before Problems Arise
The most effective risk-management tool available to a nonprofit is often strong governance.
Attorneys can add significant value by helping organizations:
- Adopt and follow written policies;
- Maintain clear reporting channels;
- Implement conflict-of-interest procedures;
- Train board members on fiduciary duties;
- Establish whistleblower protections; and
- Conduct periodic compliance reviews.
Organizations that invest in governance before a crisis occurs are generally better positioned to respond effectively when problems arise.
Practice Pointers for Attorneys
When advising nonprofit clients:
- Encourage early reporting of concerns.
- Preserve documents and gather facts quickly.
- Consider whether outside investigators or experts are needed.
- Evaluate both the risks of action and the risks of inaction.
- Review volunteer programs for potential classification issues.
- Help boards document decisions and their rationale.
- Focus on protecting the organization’s mission, people, and assets.
Strong governance, prompt investigation, and thoughtful risk management remain the best tools available to nonprofit organizations navigating internal misconduct and other organizational challenges.
Scherer Smith & Kenny LLP remains available to assist you with these and any other business, nonprofit and employment law-related questions you may have. For additional information, please contact Denis Kenny at denis@sfcounsel.com.
– Written by Denis S. Kenny