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Liability Issues for private foundations

July 6, 2011

Directors and Officers (D&O) and Errors and Omissions (E&O) liability issues for private foundations
Establishing a private foundation is an opportunity to create a vehicle for philanthropic giving during the founder’s lifetime, with the chance to leave a legacy for future generations to perpetuate the founder’s generosity. To help avoid potentially significant difficulties a foundation should be run on sound business principles, with attention paid to compliance, procedures, management, tax and filing requirements and liability issues.
 
A charitable foundation is incorporated as a non-profit – often known as a 501c3 from its place in the IRS tax code. While the directors are generally family members, it can be advisable to recruit as either a director or trustee some non-family members with relevant experience. Such experience could include familiarity with the mission of the particular foundation, philanthropy in general or professional skills like accounting or the law. Trustees generally have a greater fiduciary duty than directors because they are responsible for the control and administration of the assets while directors are typically responsible for executing the direction of management. State laws may recognize differences between the two roles and the foundation documents should clarify their respective responsibilities if the roles are to be separated.

Founders, directors and trustees often assume that a private foundation is largely insulated from lawsuits: who could find fault with giving away money? The following is a discussion of some of the risk scenarios which a private foundation could encounter.

Breach of contract. A foundation commits to a grant but before the distribution is made the administration of the recipient organization is accused of massive wrongdoing, damaging its reputation to the extent that the future existence of the organization is compromised. The foundation comdecides to rescind the grant and the recipient organization sues for breach of contract.

Fiduciary liability. Mismanagement of foundation assets. The trustees, acting in good faith, engage a money manager who makes poor investment choices. Consequently the returns on the assets of the trust significantly under-perform leading benchmarks for several successive years. Both the state’s attorney general and recipients allege that the trust assets were improperly managed and file suit against the trustees and the foundation itself.

Depletion of assets. The foundation has pledged a multi-year gift but assets are depleted before the trust is able to fulfill its obligation. The recipients sue the trustees and directors.
Wrongful acts of the trustees. A trustee issues a check in the wrong amount or to the wrong recipient and there is no realistic chance of recovery. The trustee who has issued the check is sued by the true intended recipients.
Foundations that use volunteers, engage employees or host events face greater risks. The federal Volunteer Protection Act of 1997 limits the liability of volunteers but does not prevent them from being sued. Note that the act excludes incidents resulting from the operation of motor vehicles and aircraft, so such incidents would generally not have the benefit of the federal immunity granted by the act. A foundation may engage a group of college students to help out during the summer vacation: the students are found to have disrupted the peace and caused damage to property. If the volunteers are sued they will likely look to the foundation for defense, and possibly indemnification if the courts find them liable. While coverage for the actions of volunteers would typically fall under a foundation’s general liability policy, it is possible that the directors and trustees could be sued for an alleged breach of duty, in which case the D&O policy might be implicated.

Employment practices liability. A disgruntled former employee sues for alleged wrongful termination, sexual harassment or employment discrimination.

Crime. If a trustee commits embezzlement or forgery, realistic recovery from the perpetrator may be unlikely. The foundation could then seek reimbursement of these stolen assets from its crime insurers.

Kidnap/ransom and extortion. A foundation receives threats from a group which opposes the policies of a recipient organization. At the same time, hackers repeatedly create havoc in the foundation’s computer systems.
Insurance programs for foundations should include trustees and any directors /officers as well as the foundation (entity) itself. If applicable the coverage should be endorsed to add crime, fiduciary liability and employment practices liability. Although trustees and directors have different levels of duty, as mentioned above, insurance polices often provide coverage equally; it is important to understand the extent of coverage provided for these different categories of insured.
As part of the insurance application process the foundation will usually be expected to provide audited financial or balance sheets and statements of cash flow and tax returns, unless the forms are publicly available on databases such as guidestar.org.
Just as a well-run business will ensure that appropriate insurance is in place, a foundation’s directors and trustees should insist on obtaining the relevant coverage from a sound insurer to safeguard against losses from litigation and malfeasance.

Resources
www.nonprofitrisk.org Risk management and employment information for non-profits including foundations.
www.cof.org/files/Documents/Legal/DandO.pdf
Directors and Officers Liability Insurance and Indemnification 2007, published by the Council on Foundations
www.chubb.com/businesses/csi/chubb3772.pdf Summary of the Chubb ForeFront Portfolio coverages for Not-for-profit Organizations.

Chartwell Bulletins are produced by Chartwell Insurance Services, Inc., an independent insurance broker specializing in the personal asset protection of high net worth individuals.  Chartwell Bulletins address issues of general interest and since coverages vary by company and by state should not be taken as an interpretation of a particular policy or advice on any individual situation.  

A representative of Chartwell Insurance Services, Inc. will be pleased to discuss all aspects of your personal insurance.  Contact: Rebecca Korach Woan | 312. 645.1200 | rwoan@chartwellins.com