In 2015, the Kentucky Law Journal published an article by Thomas Rutledge of Stoll Keenon Ogden, on the topic of derivative actions (lawsuits) in nonprofit corporations. The subtitle of this article: “Who will watch the watchers?” What a good question.

What exactly is a derivative action?

The derivative action is a type of lawsuit that a member or director of a corporation can bring against the board, for the benefit of the corporation. In the nonprofit context, a board member can file a lawsuit against the other board members if they are not following the bylaws or otherwise violating their fiduciary duties.

For example, let’s say you found yourself in in a situation similar to one of my own experiences. One of your fellow board members, Randy, contacts the chair ahead of an important decision. Randy makes the case to the chair that your status as a co-founder of the organization somehow creates a conflict of interest with the decision, even though the decision has nothing to do with you personally. To be fair, the decision does have a significant impact on your co-founder, the Executive Director, and her ability to carry out her job.

The chair decides to go along with Randy, and sends you a note in advance of the meeting asking you not to attend the meeting until after the decision is made. You were never sent the full meeting notice, with the time and location included, so you don’t have a choice with regard to this forced recusal.

Sure enough, the other board members hold the meeting and reach their decision. The Executive Director’s ability to carry out her duties is stripped away from her. The rest of the organization is immediately thrown into chaos as the rest of the staff bristle at suddenly getting micromanaged by Randy and the chair.

When I was in this situation, I had no idea what to do. I had no idea that I could have right then and there called an attorney to help me assert my authority as a member of the board. The attorney could have sent a demand letter, alleging the bylaws violations and damages resulting from those violations, with a demand that they cease their actions immediately.

The point of the demand letter is not that I was injured, but that the organization was injured, and that I am acting in the best interest of the organization. If the other board members continue violating their fiduciary duties, I can then move forward in pursuing a derivative action, for the good of the organization.

The board must police itself

The board of directors is meant to serve as the group of people overseeing the organization, to ensure that the organization is managed well by the Executive Director and is in compliance with applicable laws and agreements. But if a director or group of directors acts with gross negligence, or if they take it upon themselves to micromanage the day-to-day affairs of the organization, or unduly oust the Executive Director (or founder, for that matter), damaging the organization in the process, who will hold them accountable?

There are multiple avenues for holding a board accountable, most of which are not particularly adequate. Rutledge argues that the derivative action is the best available tool:

A derivative action recognizes that persons other than the entity have standing to initiate an investigation of management and the propriety of its actions, an important mechanism of enforcement of fiduciary duties. The Connecticut Supreme Court described this mechanism, stating that:

“[i]f the duties of care and loyalty which directors owe to their corporations could be enforced only in suits by the corporation, many wrongs done by directors would never be remedied.”

As such, the derivative action serves as an important policing function in providing a mechanism by which those charged with management and control of a venture may be called upon to demonstrate that they are in fact discharging the obligations they have voluntarily undertaken. Ergo, in response to Juvenal’s famous query, “Who will watch the watchers?,” it will be the court acting at the instigation of those with a relationship with the venture other than through control.

Few alternative mechanisms exist beyond the derivative action. Depending on the nature of the board’s behavior, you can file a complaint with the IRS, or you can try to convince your state’s Attorney General to go after the board. If you file a complaint with the IRS, you better hope that you have your corporate record book in very good order, or else you could be implicating yourself. If you contact your state’s Attorney General, good luck trying to convince the AG to go after a group of volunteer community leaders.

At the end of the day, it’s up to you to either find an attorney willing to represent you pro bono (unlikely), or for you to be willing to shell out the cash yourself to hire an attorney. The other alternative is to find an attorney who is willing to represent you on contingency, but that type of agreement will really just incentivize the attorney to reach a monetary settlement, without regard to whether you actually win or not.

Stacking the odds

If you make it to a court room, the only legal leg you’ll have to stand on is to assert your claim that the other board members violated the bylaws. Although you are still a member of the board, the other board members will generally be referred to as “the Board,” even though they are technically not “the Board” without you. They’re a group of board members. They’re a faction. And every time they meet without telling you, they are violating the bylaws. Is your attorney going to be willing to reassert that plain fact over and over?

Don’t get me wrong: courts do take bylaws very seriously. Those other board members clearly did not follow the bylaws, and you should be able to get a quick ruling in your favor stating as much… at which point, the other board members can go back, call a board meeting in the proper way according to the bylaws, and (if they are a majority) reach the same decision that they reached before. According to the law, the problem was the process, not the actual decision.

If the court can be convinced that the board members acted recklessly or with malice intent, then it’s not a broad step further to convince the court that those board members should be removed and replaced.

What are the chances of that happening? Let’s turn to another law journal article for a hint on the answer to that question. Eileen L. Morrison wrote an article “advocating for expanded standing for beneficiaries” in derivative suits (emphasis mine):

The duty of care is the standard of conduct pursuant to which directors discharge their responsibilities. Directors must fulfill their responsibilities diligently and make informed decisions. Only actions (or failures to act) that amount to gross negligence are considered violations of the duty of care. However, courts do not often find that a director has violated her duty of care because of the business judgment rule, which is a judicial presumption that board members act in an informed manner, in good faith, and in the best interest of the corporation. Derived from the for-profit corporate context, the business judgment rule also applies to nonprofit directors. In practice, nonprofit directors are held to an even lower standard than corporate directors. The theory behind the business judgment rule is that authorities and judges should not second-guess board members’ business decisions. However, the business judgment rule does not apply when directors abdicate their responsibilities and fail to act or act in bad faith.

So, in essence, there are few mechanisms available to make sure boards of directors and their members behave themselves. And the best mechanism available is a very complex type of civil action that — thanks to its complexity — is very expensive to initiate. And, on top of that, the odds of prevailing in a case are not very good unless you have rock-solid-smoking-gun evidence to back up your allegations.

Board coups work, unless you’re wealthy

If you are a founder of a nonprofit organization and you don’t have much wealth to depend on, think twice before you treat the drafting of your bylaws as a minor distraction. Think twice before you get desperate to fill board seats with whoever is willing to serve. Think twice before you treat any matter relating to corporate governance with even a shred of informality, as though a board coup could never happen to you. And most of all, think twice before you speak an unpleasant word toward anyone around you, whether that’s a board member, staff member, volunteer, or anyone. Before you know it, the people you thought you could trust the most will turn their backs on you as your name gets unfairly tarnished. And if you’re not wealthy enough to hire a good attorney, you will not have any good recourse. You, the organization, the organization’s clients, and the mission as a whole will all suffer the consequences of your ouster.

In the law enforcement world, the concept of the thin blue line is used to convey the idea of the police as the very small group of people who keep society from descending into chaos. Whether you agree with that concept or not, you have to admit, there exists today no effective “thin blue line” to prevent nonprofit boards from descending into chaos. The idea of self-policing boards only works for larger organizations — the types of organizations that framers of 501(c)(3) law certainly must have had in mind, back in the day. There is no thin blue line for smaller organizations, whose founders can’t afford justice.

Today, there are hundreds of thousands of small nonprofit organizations. As I made my case in an earlier post, there are more than 180,000 organizations with expenditures of less than $500,000:

That’s 180 thousand small and very small organizations, together comprising 180 thousand ambitions to make the world a better place, with very few resources at their disposal compared to the rest of the field. That also means 180 thousand opportunities for anyone to throw an organization into disarray in the course of pursuing or abusing power.

You would be surprised to find out how quickly a single person can enter one of these organizations as a board member and create chaos that they intend to take advantage of for their own personal benefit. Executive Directors, especially women, often find themselves the targets of these takeover attempts.

Many times, it begins with a narcissist (“Randy” in my earlier example) suggesting in very subtle ways during board meetings that they are in some way more competent or qualified than the executive director. The moment something bad happens, that’s when the chaos erupts. It ends with multiple people’s reputations in tatters, a charitable organization no longer able to function, and good people facing a long recovery from post-traumatic stress. Good people made great sacrifices to build the organization and pursue a noble mission, only for a narcissist to come along and tear the whole thing apart.

Reform the corporate shield

Nonprofit organizations need a better mechanism to resolve disputes without resorting to lawsuits or traumatizing chaos. And board members need to be held to better account.

When we had our dispute, my co-founder and I pleaded with the other board members multiple times to at least return to a state of abiding by the bylaws. We offered to bring in an outside facilitator to help resolve the dispute we were having and bring us back together as a whole board again. Several board members agreed to work with us to find that right facilitator. But Randy worked behind the scenes to sabotage any consensus we had.

I like to believe that had it not been for Randy we would have found a way to come back together amicably. With a decent, independent facilitator or mediator brought in at the right time, I believe the organization would have had a much better chance of survival. This solution would have been far less expensive and less damaging to the organization. Take an approach akin to restorative justice, which some might refer to as “restorative HR.” This is likely the best possible approach, even if it’s not the only approach to resolving disputes.

But, more to the point, a legal mandate to seek facilitation or mediation would go a long way toward resolving a lot of these types of disputes, and would hopefully also blunt the impact of a Randy on the board. If directors violate that mandate, they should lose the protection of the corporate shield, and they should be denied D&O coverage. A refusal to move toward an amicable solution is a sign of bad faith.

A mediation mandate, with the threat of losing the corporate shield, would go a long way toward establishing a more fair “thin blue line” to prevent organizations from descending into needless chaos. I hate to overstate the potential impact that this type of change could have, but I believe it is a small change that could make a significant difference, even if it is not 100% effective.

As for myself, if I can find a way to insert such a mandate into the indemnification clause in an organization’s bylaws, I will certainly try.