What’s a Conflict of Interest?

A nonprofit’s board of directors has a responsibility to support the organization’s best interests over those of any board member, elected officer, or staff member. A conflict of interest arises when an actual or perceived interest by a board member, elected officer, or staff member results in or appears to result in personal, organizational, or professional gain.

Common Conflicts of Interest

Conflicts of interest can take many forms. Some common conflicts of interest include:

  • Two or more board members from the same family
  • A board member and an employee from the same family
  • An elected officer or staff member who’ll make financial gains based on the nonprofit’s activities
  • Individuals that may serve a dual role within the organization.

Even certain gifts can create a conflict of interest. That makes it critical to define what constitutes a conflict of interest in your nonprofit as the definition may vary from organization to organization.

Permitted Actions

Check with your secretary of state’s office for any state-specific rules regarding conflicts of interest because states may differ in what they permit and prohibit. However, most states allow the following:

  • Reasonable Compensation for Services Permitted: While nonprofit board members usually commit their time on a volunteer basis, nonprofits may pay reasonable compensation to directors who provide services on behalf of the organization. So who determines what’s reasonable? The Internal Revenue Service (IRS), your state’s attorney general, donors, and the public separately make that determination by reviewing all the facts and circumstances of the situation.

    If a nonprofit decides to pay any board member more than $600 per year in reasonable compensation, it must file Form 1099-MISC with the IRS. Some, but not all, nonprofits address and limit compensation for board members in their bylaws. Keep in mind, however, that board members who receive compensation may lose immunity from lawsuits against the nonprofit they serve in states that protect volunteer board members from lawsuits.
  • Interested Director Transactions (If Fair and Authorized): An interested director may conduct a transaction with a nonprofit as long as the nonprofit’s board of directors authorizes the transaction and considers it fair. For example, a nonprofit board member who owns a catering company might offer catering services for the nonprofit’s annual gala at a discounted rate. The rest of that nonprofit’s board of directors may consider this a fair transaction if the board votes on it after also considering offers from other caterers.

    A nonprofit board of directors must evaluate the material facts of any interested director transaction — as well as any potential conflicts of interest associated with it — and then vote on whether or not to approve that transaction. The board’s meeting minutes should carefully document this entire process.

Prohibited Actions

While states also can differ on what they disallow for nonprofits, here are two actions every state prohibits:

  • Financial Loans: Under no circumstances may a nonprofit pay dividends or lend money to a board member. Any other board member who allows such a loan to occur assumes personal liability for the entire amount of the loan until it’s repaid.
  • Private Inurement: In order for the IRS to consider a nonprofit organization a public charity, no part of the organization’s profits and revenue may benefit a private individual. State laws also prohibit any part of a nonprofit’s profits from benefiting a private individual.

Why Should You Have a Conflict of Interest Policy?

Federal law requires nonprofits to adopt a conflict of interest policy — and some states have a similar requirement. While nonprofits enjoy tax-exempt status, they still must file Form 990 with the IRS. That form asks if an organization has a conflict of interest policy, how its board of directors determines whether or not a conflict of interest exists, and how it addresses any identified conflicts of interest. Certain states also may have specific requirements nonprofits must include in their conflict of interest policies. Keep all of this in mind when forming your own nonprofit.

In addition, conflict of interest policies prevent board members or other decision-makers from benefiting based on the services they provide to a nonprofit. Adopting a strong policy can help your nonprofit avert the legal and reputational consequences often associated with a conflict of interest. Furthermore, implementing and upholding a conflict of interest policy promotes a culture of candor over conflict. Transparency within an organization fosters trust across all levels — an important factor for long-term success and growth. In the case of nonprofits, especially public charities, trust and transparency matter even more. The public, your donors, and your staff need to trust the organization they support.

What to Include in Your Conflict of Interest Policy

As you draft a conflict of interest policy for your nonprofit, be sure to consider how you’ll ensure anyone with a conflict of interest discloses their conflict, how you’ll address conflicts, and how you’ll prevent interested board members from voting on matters for which they have a conflict.

Strong conflict of interest policies include the following:

  • The Policy’s Purpose: Conflict of interest policies help guide a nonprofit in fulfilling its mission by considering the organization’s best interests and creating a culture of trust. Usually outlined in the first section of such policies, a description of purpose should include language about identifying, disclosing, and managing conflicts of interest whether actual, potential, or perceived.
  • Conflict of Interest Definitions: All organizations should avoid common conflicts of interest, such as those noted above. However, you also may face conflicts of interest unique to your organization and/or its board members, elected officers, and staff. That makes it critical for your policy to clearly define what constitutes a conflict of interest in your organization.
  • Procedures for Addressing Conflicts of Interest: Such procedures are essential for creating an effective policy. Once you define what constitutes a conflict of interest in your nonprofit, you should identify any actual or potential conflicts of interest. Be sure to record these conflicts in your board’s meeting minutes to make everyone aware. Next, outline the steps your organization should take to address any current or future conflicts of interest. If a board member has a conflict of interest, for example, you’ll likely want to prevent that person from participating in discussions or votes on any matter related to that conflict. While appropriately handling a conflict of interest can benefit a nonprofit by enhancing the public’s trust in the organization and by avoiding costs related to any lawsuits, poor management of these conflicts can lead to legal and reputational issues.

To see an example from another nonprofit organization, check out this sample policy for a hospital (scroll down to Appendix A). If you’d like help drafting your organization’s conflict of interest policy or simply have questions about what to include, consider hiring an attorney experienced in this area.

Once you finish drafting your policy, ask each board member to review it and suggest any necessary edits. When all board members agree to a final version, have them conduct a vote to formally approve the policy and then add their signatures to that approved policy. Additionally, whenever your board prepares to vote on an issue, its members should check if any actual or potential conflicts of interest exist before voting. If any conflicts do arise, board members should address them per the procedures outlined in your nonprofit’s conflict of interest policy.

Conclusion

Drafting a conflict of interest policy and addressing actual, perceived, or potential conflicts of interest early can help your organization avoid facing complicated issues related to such conflicts. By clearly defining conflicts of interest, identifying existing and potential conflicts, and establishing guidelines for addressing them, your organization can greatly minimize the risk of legal and/or reputational consequences stemming from conflicts of interest.

Because a conflict of interest policy is one of your nonprofit’s most important policies, regularly review it with your board to ensure it remains up-to-date and applicable. Take time to carefully craft your policy and then remember to have your board review it and vote to approve a final version to ensure everyone’s on the same page. You also may want your board of directors to sign your conflict of interest policy annually to ensure everyone reads and agrees to its rules.