Spring 2003

In this issue:
Deciphering the D&O Dilemma
Is Now the Time to Start a Related 501(c)(3)?
Making the Board Retreat a Hit

“Deciphering the D&O Dilemma”
Of all the multiple types of insurance coverage organizations should consider, directors’ and officers’ (D&O) insurance is usually the most complicated.

The complexities related to D&O coverage, which indemnifies an organization’s directors and officers for claims brought against them, make it difficult for many nonprofits to determine whether they truly need to obtain the coverage and, if so, which provisions are essential.

The Case for D&O Coverage
Escalating premiums have driven many not-for-profit organizations to reassess their need for D&O coverage. While D&O premiums had been among the most reasonably priced, the troubled economy and the post-9/11 drain on the insurance industry have caused insurance premiums across the board to surge. Nonetheless, D&O coverage remains advisable for most not-for-profits for several reasons.

Although many states have enacted statutory limits on the liability of some not-for-profit boards, the organizations can still be sued. In fact, not-for-profits are increasingly incurring substantial costs to defend themselves against a variety of claims.

Claims involving employees are by far the most common, including charges related to:

Discrimination

• Wrongful discharge

• Sexual or racial harassment

• Hiring, promotions, and compensation

• Failure to supervise

• Invasion of privacy

• Defamation

According to statistics on court filings, employment-related claims are skyrocketing across all industries and show no signs of letting up. Board members are vulnerable to these suits when they approve personnel policies that are alleged to violate the law, but few comprehensive general liability policies provide coverage for employment practices.

Employees aren’t the only ones bringing claims, though. Nonprofits are also facing suits by donors over the use of their donations, board members over board decisions, beneficiaries unsatisfied with their disbursements, and attorneys generals over a variety of matters such as antitrust.

Board members and officers can basically be sued over any injury allegedly caused by mismanagement or poor governance.

Litigation of any kind can quickly eat through a not-for-profit organization’s financial resources, making the premiums for D&O coverage seem paltry by comparison.

The Right Stuff: Policy Provisions
Unlike most forms of insurance, there is no standard "form" for D&O policies – each insurance company drafts its own language, so a not-for-profit organization should have some room for negotiation. To obtain the greatest protection, the organization should ensure the policy provides for the following:

• A broad definition of "insured." The policy should cover any individual who was, is, or becomes a director, trustee, officer, employee, or volunteer, as well as the organization itself (i.e., entity coverage).

• Advancement of defense costs and preapproval of defense counsel. Legal costs can consume a not-for-profit’s cash in no time, so the policy should provide that the insurer will pay the costs as they are incurred. Disagreements over defense counsel can delay proceedings and compound costs.

• Broad coverage for employment practices. This is probably the single most important provision, as the majority of claims the organization will face will be employment-related and thus not covered by a comprehensive general liability policy.

• Non-cancellable. The policy should be non-cancellable, except in the case of non-payment of premium. Also, organizations should require at least a 90-day written notice of non-renewal.

• Pricing. Secure express commitment for multiple-year pricing or language restricting premium increases.

When Is Coverage Triggered?
An organization should also pay attention to the trigger of coverage in the policy. Most D&O policies provide "claims made" coverage, meaning coverage is triggered only if both the incident underlying the claim and the claim itself take place during the policy period.

Under an "occurrence" policy, coverage extends to any claims based on events that occurred during the policy period, regardless of whether the claim is made after the period expires. The latter coverage is typically a bit more expensive, but the cost may be worth the peace of mind.

Caveats
Not-for-profits that already maintain D&O coverage may wonder whether they should increase their coverage.

Before doing so, they should look at other measures that are available to limit their risk.

Organizations should carefully assess their most vulnerable areas of exposure and address issues at the root of that exposure. It may be more cost-efficient, for example, to revise employment contracts or manuals or to invest in ergonomic workstations.

And not-for-profits should remember that, while a D&O policy provides a defense against allegations of illegal acts, it doesn’t provide insurance for the acts. If the defendant is found guilty of intentional wrongdoing, the insurance company won’t pay damages.

“Is Now the Time to Start a Related 501(c)(3)?”
Because the majority of associations are tax-exempt as 501( c)(4) or 501(c)(6) organizations, they often miss out on the advantages available only to 501(c)(3) organizations. Associations may, nonetheless, be able to leverage some of those benefits by forming 501(c)(3) affiliated organizations, also referred to as "related 501(c)(3)s."

Associations should, however, carefully consider all of the implications before launching such a venture.

Advantages of Related 501(c)(3)s
Related 501(c)(3)s boast numerous benefits:

• Ability to offer charitable deductions for contributions made directly to the 501(c)(3)

• Eligibility for federal and state government grants

• Exemptions from many state and local sales and use, real estate, and other taxes

• Eligibility for grants from private foundations without having to show "expenditure responsibility"

• Nonprofit postal permits at much lower rates

• Eligibility to issue tax-exempt bonds

• Ability to conduct deferred-giving programs, charitable bequest programs, pooled income funds, and charitable gift annuities

Related 501 (c) (3)s can engage in a variety of familiar association activities, including publishing, seminars, research, grants and scholarships, and awards. Note, however, that while educational activities may be restricted to a selected target audience, such as members of a certain profession, they may not be restricted to the association’s members.

Related 501(c)(3)s can also make contributions to their parent association, and vice versa. The rules can be complicated, though, so a CPA should be consulted to ensure compliance with the tax code.

IRS Requirements
An association’s "affiliated organization" must satisfy several requirements. For example, it must use the funds it raises for educational, charitable, or scientific purposes. Many associations, however, already perform educational, charitable, or scientific functions, which they could simply transfer to the affiliate organization.

A greater obstacle might be presented by the requirement that the association and its 501(c)(3) maintain separate corporate existences, with no inter-mingling of financial, managerial, or operational practices.

In examining the issues, depending on the nature of the particular 501(c)(3), courts and the IRS will look at several factors:

• Whether a valid purpose exists for establishing the organization

• Whether the association is involved in the daily management of the organization

• The extent to which the organizations share directors, officers, or staff

• The extent to which the organizations share facilities or services

Thus, the 501(c)(3) must conduct its own board meetings, keep its own financial records, allocate joint program expenses and overhead, and clearly identify itself as its own entity on, for example, its letterhead.

Some associations may find the recordkeeping, allocation, and administrative requirements too burdensome when weighed against the benefits.

“Making the Board Retreat a Hit”
Board retreats present a valuable opportunity to tackle topics and issues that normally can’t be adequately addressed at standard board meetings.

Benefits of Board Retreats
Nonprofit organizations have discovered that many benefits can be reaped from board retreats. Retreats allow board members to brainstorm in a new environment, free of barriers like the routines, procedures, and hierarchies typical of board meetings. And allowing more time for brainstorming often results in more creative thinking.

Board retreats are also useful for clarifying roles, responsibilities, and expectations. They allow board members to build relationships with each other and improve teamwork. They energize new members and re-energize veterans, while ensuring that everyone is on the same page, working with a common vision toward a common future.

A board retreat can be used to accomplish a variety of goals, including:

• Strategic planning

• Education on relevant industry or organization issues (e.g., changing member demographics, fund raising)

• Board development/assessment, including its roles, responsibilities, and effectiveness

• Improved communication

• In-depth examination of implications of new initiatives

A retreat, however, shouldn’t focus on more than two issues, and even those should be prioritized to achieve maximum accomplishment.

Handling the Logistics
The first decision will be when to hold the retreat. An effective board retreat can run from four hours to two days, depending on the size of the organization and the board.

In the case of a two-day meeting, it’s generally best to hold the retreat over a weekend, with, for example, Friday night socializing and ice breakers, followed by an all-day meeting on Saturday. When retreats are held over two half-days, the attendance is more likely to vary, which can hurt productivity.

Regardless of the decision regarding duration, board members should be given as much notice as possible to achieve the optimum participation. Ideally, the board members’ job description should include attendance at retreats, so that attendance seems more obligatory.

Location is also important. It’s essential to get away from headquarters, as well as the sites where board meetings are held. Cost-conscious organizations can achieve the requisite change in setting at a low cost by using local colleges, libraries, or similar facilities.

To avoid wasting valuable board meeting time, a planning committee should be established. The committee will handle additional critical meeting details, with powers to delegate and oversee tasks. It should be small but representative of varied perspectives.

If the organization will be retaining the services of a facilitator, the facilitator should be involved in the planning. The facilitator will also participate in the retreat, promoting communication from an impartial position – he or she guides discussion but doesn’t render opinions.

A facilitator keeps the retreat on track and on time, while encouraging participation by all in attendance, including senior staff where appropriate. A facilitator can also act as mediator, helping attendees resolve disagreements by compromising or finding common ground.

Board members should have the opportunity to contribute to the planning, of course. A pre-retreat survey will foster their personal investment in the success of the retreat, while preventing the meeting from being dominated by a particular participant or faction with its own agenda.

To make the most of the time allotted for the retreat, board members should be informed about the issues to be discussed in advance of the meeting. They should receive an agenda and an explanation of the retreat’s objectives, as well as any additional materials or resources they might need to prepare and to participate fully.

Ground rules should also be distributed before the meeting, with rules designed to promote brainstorming, participation by all, and mutual respect.

After the Retreat
A post-retreat survey can be used to measure the retreat’s success. Use the survey to assess the attendees’ sense of accomplishment, recognition of specific outcomes, and enthusiasm for another retreat. Written objectives established in the planning process can also be compared to retreat outcomes to measure success.

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