While being recruited for and serving on the board of a nonprofit hospital or health system can be an honor, trustees are accountable for the organization’s actions. In light of the federal government’s increased emphasis on regulatory compliance and False Claims Act enforcement, this responsibility should not be taken lightly. Board members are legally required to be informed and active participants in corporate governance in acting to fulfill the nonprofit’s charitable mission. This is a primer on the legal obligations and best practices that trustees can implement to create an effective board.
The Fiduciary Relationship
A person who has a relationship of trust or confidence with another is called a fiduciary. A fiduciary’s relationship with an organization is one-sided, meaning that the relationship is designed to meet only the needs of the organization and the fiduciary must act without regard to his or her own needs. In hospitals and systems, board members are fiduciaries because they have been entrusted with overseeing the fulfillment of the organization’s mission. They must be principally concerned about the performance of the nonprofit and that its interests are pursued faithfully.
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The law recognizes that because fiduciary relationships may occur outside of any contractual relationship that would allow the organization to enforce its rights, fiduciaries should be held to certain standards. This provides the organization with incentives to enter into fiduciary relationships by reducing the risk of abuse of entrusted power and ensuring high-quality fiduciary services.
This relationship between board member and the organization is a legal one, and board members have an obligation to monitor and oversee not only the organization’s financial dealings, but its ongoing regulatory compliance program.
Legal Duties
A board member’s central purpose is to ensure that the organization’s resources are used to achieve its purposes. This includes the duties of care, loyalty and obedience.
Duty of care: A trustee has a responsibility to participate in decision-making on behalf of the organization, and must exercise independent judgment while doing so. These decisions must be informed, meaning that the board member should make efforts to become familiar with the relevant, available facts. For example, members should require management to provide sufficient information to make an independent decision. If board members find that the information is invalid or incomplete, they are expected to ask questions about it. Independent advice is required if the nonprofit is buying or selling significant assets, or is entering into a material contract. This is especially important if the organization is entering into a joint venture, sale or merger, or if the company presenting the information stands to benefit from the transaction, such as the continuation of a management contract when management is a company organized separately from the health care organization.
With respect to corporate compliance, the duty of care requires that board members “attempt in good faith to assure that (1) a corporate information and reporting system exists, and (2) this reporting system is adequate to assure the board that appropriate information as to compliance with applicable laws will come to its attention in a timely manner as a matter of ordinary operations,” according to information published by the Office of the Inspector General and the American Health Lawyers Association.
Failure to comply with fraud and abuse statutes, patient privacy regulations and other federal and state laws can expose a hospital or system to significant criminal and civil monetary penalties that could directly impede its ability to provide care. In certain cases, health care organizations are excluded from participation in Medicare, Medicaid and other federal health care programs for a period of five years or more. Exclusion and the loss of reimbursement payments can be fatal to a hospital or system.
Duty of loyalty: When acting on behalf of an organization, board members must set aside their own interests, whether professional or personal, or the interests of any other organization. Simply put, the nonprofit organization must come first. A board member cannot seize an opportunity for his or her own gain. Even if it is only part of the organization’s future plans, the opportunity must be presented to the organization first. Similarly, it is a breach of the duty of loyalty to fail to preserve the confidentiality of the organization’s affairs. Disclosing opportunities to outside individuals may lead to loss of opportunity for the organization.
Duty of obedience: Board members have a responsibility to be faithful to the organization’s stated mission and not to act or use its resources in incompatible ways or purposes.
Complying with these obligations can protect a nonprofit board. As long as decisions of the trustees are made on an independent and informed basis, in good faith and in the best interests of the corporation, they are not subject to challenge in court. This presumption is called “the business judgment rule,” and applies unless there is evidence showing a board member has an interest in the transaction or dispute or was otherwise disloyal, uninformed or lacked independence.
The Consequences
If a board member breaches any of these duties or otherwise harms the nonprofit organization or its stakeholders, he or she may be personally liable for failing to comply. However, trustees also should be familiar with state laws governing nonprofit organizations. In Tennessee, for example, state law grants board members immunity from legal actions related to breach of fiduciary duty unless the breach involves “willful wanton conduct” or “gross negligence."
Members of the organization may sue a trustee on the organization’s behalf because of a breach of duty in a type of lawsuit called a derivative action. Donors also may sue, alleging misuse of gifts or assets.
The government may bring actions against board members for violation of state or federal laws. Such lawsuits may allege failure to fulfill the organization’s charitable purpose. In some states, this can lead to the dissolution of the hospital or system under the receivership of the court.
Board members additionally are charged with fulfilling the charitable purpose of the organization, and its patients, employees, medical staff, creditors and the public may hold them accountable. These outside parties may attempt to sue a member of the board directly in a suit alleging harm done by the organization.
Avoiding Liability
Board members can meet these duties and avoid liability by taking the following four actions.
1. Establish appropriate policies. To avoid breaching the duty of loyalty due to conflicts of interests, boards should adopt and follow a written conflict-of-interest policy that prohibits members from engaging in either business or financial transactions with anyone directly connected to the organization. Alternatively, the policy should clearly state the conditions under which it would be acceptable to conduct business with an organization with which there is a conflict. It can be helpful to have board members sign a disclosure form on an annual basis that identifies potential conflicts.
If a conflict of interest still arises, the board member should make a full disclosure of the conflict to the rest of the board. It may be appropriate for that member to withdraw from any discussion concerning the transaction; however, there are instances when he or she might be particularly knowledgeable on the subject and in a position to impart information that will help board members who are not conflicted to reach a decision. However, the conflicted board member should abstain from voting on the issue in all cases. The Internal Revenue Service has adopted rules applicable to certain transactions that create an assumption that the nonprofit organization acted appropriately in a conflict situation unless that assumption is contested with evidence.
Board members also may wish to develop a confidentiality policy. Although the duty of confidentiality already exists, having a formal policy in place may help members analyze how that duty applies in their organization. The policy may include provisions about how to define what matters are confidential or when or if to make statements to the press or public.
Boards also should adopt a code of conduct that is adapted to the organization’s specific needs. It may include a commitment to ethics and compliance, standards of conduct or patient care, standards for employees, and standards for business practices, and can serve as the first step to implementing the code of conduct across the entire nonprofit organization.
2. Establish appropriate committees. In addition to policies, the board should consider establishing committees that will allow a detailed review of board-level matters that time would not allow during a board meeting. This may include the following:
- executive committee that can act between regularly scheduled board meetings
- audit committee
- finance committee
- nominating/board development/governance committee
A governance committee can oversee trustee recruitment, orientation and evaluation. It also can oversee governing processes, such as the process for identifying conflicts of interests. The governance committee also may review written policies to confirm they are enforced and effective and, if not, whether any revisions are necessary.
The board also should establish an audit committee. While the Sarbanes-Oxley Act primarily applies to for-profit companies, many nonprofit organizations have either voluntarily adopted its requirements or are required to follow its requirements under state regulations. Regardless, a financial audit can make sure that safeguards are appropriate. A committee dedicated to working with outside independent auditors allows board members with financial expertise to focus their efforts and make best use of their knowledge by implementing the auditor’s suggestions.
In addition, the board may establish a special committeewith limited powers for a specific purpose. These committees may conduct an investigation to recommend action on a specialized matter, such as litigation. Special committees should report directly to the board and be dissolved when they have fulfilled their purpose. It’s important to note that not all members of a special committee need to be board members if specialized expertise is needed to address an issue.
3. Establish measures for effective board performance. The board also should schedule strategic planning and mission evaluation on a regular basis. This will require the board first to define what constitutes success of the nonprofit organization’s mission. The board may conduct a self-evaluation, but also may choose to survey the organization’s staff or members about the metrics to measure success and the best use of resources. Trustees also may look to the experience of comparable nonprofit organizations. For providers participating in Medicare, the board should be aware of and be able to track compliance with quality of care metrics, compliance with Medicare Conditions of Participation and Conditions of Payment.
4. Review organizational and external resources. Board members should maintain copies of the organization’s mission statement, budget, strategic plan and an overview of programs and staff. These resources can be a useful reference when considering how to fulfill the chartable purpose of the nonprofit.
Board members may refer to the American Bar Association’s Guidebook for Directors of Nonprofit Corporations, the American Hospital Association Center for Healthcare Governance’s Guide to Good Governance for Hospital Boards, and Corporate Responsibility and Corporate Compliance: A Resource for Health Care Boards of Directors, published by the Office of Inspector General and the American Health Lawyers Association.
Organization Comes First
The standards to which a fiduciary is held are the highest imposed by law, and nonprofit board members are required to meet them. To do so, and to ensure the continuing success of the nonprofit, trustees must understand both the mission and the operations of the organization and take practical steps to uphold their fiduciary duty.
Paul S. Davidson (paul.davidson@wallerlaw.com) is chairman of health care litigation and a partner, and Tera Rica Murdock (terarica.murdock@wallerlaw.com) is an associate, at Waller, Nashville, Tenn.
