Written by David L. Sevalrud
As we discussed in Part One and Part Two of our series on the roles and duties of directors in a combination transaction of non-profits (“NFP”) and/or charities, the Board of Directors (“Board”) of a NFP must be diligent in order to avoid any potential conflicts of interest, including the perception of any conflicts.
Some examples of potential conflicts of interest that the Board may encounter, as well as suggestions for managing or avoiding such conflicts, are below:
- Where a Board member is also a Board member of the other NFP organization being considered for a combination, there is an automatic conflict of interest.
- If there is undisclosed information about the circumstances of one of the NFP organizations, such as a pending lawsuit, or a risk of the organization losing its charitable status or becoming insolvent, such information is generally confidential. As director of that NFP organization, he or she must maintain all information in confidence unless the Board agrees otherwise.
- However, as a director of the other NFP organization, there is also an obligation on the director to disclose information that is material to that organization.
- Consequently, the director cannot maintain his or her duty of confidentiality and also maintain the duty to disclose material information at the same time.
- In the context of a potential combination, full disclosure by each NFP organization will be important. If both NFP organizations agree to fully disclose existing and potential material risks, then the duty to keep such information confidential will be varied by the agreement of the Board to disclose. For that reason and provided there is an appropriate non-disclosure agreement in place, a conflicted director may be able to avoid breaching the duty to disclose confidential information.
- In any other circumstances, the director may need to resign from one or both NFP organizations to avoid a breach of duty. Legal advice should be obtained when these circumstances arise.
- Where a Board member is also an officer of the other NFP organization, there may be a conflict of interest or the perception of a conflict of interest.
- CEOs and Executive Directors may be conflicted because the combination negotiations will necessarily include the recruitment or retention of the CEO or Executive Director from one of the combining organizations (or in some cases from outside). If a CEO could either lose his or her job or become the CEO of a larger organization, his or her personal motivations can be perceived as a conflict, even if they are able to act with independence.
- Where appropriate, the Board of a NFP may need to form an independent special committee (“Special Committee”) to consider the combination transaction. Special Committees should be considered if:
- The NFP organizations involved in the proposed combination are large;
- The proposed combination will be complex;
- The NFP organization is insolvent or on the brink of insolvency; or
- There are conflicts of interest that can be addressed adequately by the use of an independent special committee.
In such cases, it may also be appropriate for the Board and its Special Committee to retain independent legal counsel.
The Board and the Special Committee should also address such issues as:
- Composition: members of the Special Committee should be Board members with some expertise relevant to the combination transaction being considered, such as accounting, legal and human resources expertise. Officers should not be part of a Special Committee (even if they are on the Board) as they will not be considered independent for this purpose.
- Duties: the Special Committee would typically be tasked with performing or overseeing the due diligence process and the negotiations, and to then make a recommendation about the proposed transaction to the Board without the influence (or perceived influence) of conflicts.
- Mandate: the Special Committee should have an appropriate mandate from the Board. In most cases, the Board will grant some limited authority to the Special Committee to engage experts or advisors to work directly with the Special Committee (including but not limited to independent legal counsel).
The Board and its relevant committees may need to meet more frequently during a proposed combination transaction in order to be informed, to have an opportunity to ask questions, and to carry out their process. Some Boards may need to meet monthly or weekly while a Special Committee may need to meet more often. Where time frames are short, Boards and committees will generally need to meet more frequently, engage more outside expertise and give significantly more time to the process in order to maintain credibility and the credibility of the Board’s ultimate decision and recommendation.
If a Board lacks the experience or expertise to enter into a proposed combination, they will need to ensure they engage the appropriate experts. In some cases, it may be possible to recruit new Board members who have specialized experience or expertise, although it is usually very difficult to attract new Board members to an organization that may be facing insolvency.
Carscallen LLP’s Charities and Not-For-Profit Organizations Expertise
Carscallen LLP’s team of experienced corporate and commercial lawyers have advised a range of NFPs with legal advice tailored to the field of charity and non-profit organizations. Our lawyers can assist with such issues as structuring, organization and governance of NFPs, as well as advising on regulations and compliance issues for NFPs.
Whatever the legal issue, Carscallen LLP’s Charities and Not-For-Profit Organizations team can help guide your organization through a complex legal landscape. If you have any questions about directors’ roles and duties in a NFP combination, or any other legal questions for our team, please contact us.
*This update is intended for general information only on the subject matter and is not to be taken as legal advice.