Courts, Constituencies, and the Enforcement of Fiduciary Duties in the Nonprofit Sector

Abstract

Directors of nonprofit organizations owe fiduciary duties to their organization, but the content of these duties--and how and when courts should enforce these duties--has long been debated among scholars and courts.  This debate emerges in several areas, including the level of deference to be shown by courts to nonprofit directors (the business judgment rule), who should be allowed to sue to enforce duties (standing), and the type of relief available to prevailing plaintiffs (remedies).  Existing literature debates these legal rules in isolation and in abstraction, generally failing to consider how the rules interact with each other and ignoring the empirical reality of the nonprofit sector.

Because for-profit and nonprofit corporations evolved from a common ancestor, courts generally apply the corporation law principles developed in the context of for-profit corporations to nonprofit corporations as well.  But for-profit and nonprofit corporations often differ in key ways, including sources of income, constituencies, and other institutional characteristics. These differences make rote application of corporate law principles to nonprofit corporations a conceptually questionable endeavor.  Rather than setting nonprofit rules through strained analogies to for-profit concepts of ownership and profit-maximization, we propose employing an analysis of institutional features that can operate in a whole range of governance contexts, including the nonprofit sector.  This approach considers opportunities for voice and exit, impact range, homogeneity, and comparative competence between boards and courts, and it does so among different types of nonprofit actors, like directors, members, employees, donors, customers, and beneficiaries. 

Using this institutional analysis with for-profit corporation law as the baseline, we compare emerging legal rules in the nonprofit sector against existing empirical literature.  We find that, with one exception, institutional characteristics vis-à-vis nonprofit actors are reasonably comparable to their for-profit counterparts, and we therefore place the applicable legal regime with respect to those actors on a more conceptually sound footing.  However, beneficiaries of a nonprofit organization tend to lack opportunities for exit or voice, face risk of considerable deprivation, and often differ considerably in relevant aspects from the individuals who manage the organization.  We argue that the law should take into account the limited power of beneficiaries in nonprofit governance structures, and we analyze options for reform.