What are bylaws and why do we need them?
How can they protect the board?
Bylaws are the written rules by which an organization is governed. They set forth the structure of the board and the organization. They determine the rights of participants and they determine the procedures by which rights can be exercised. In other words, bylaws guide the board in conducting business. Carefully crafted bylaws and adherence to them can help ensure the fairness of board decisions and provide protection against legal challenges.
It’s important to note that bylaws are in fact legal documents. This means there are legal requirements for what should be included. These requirements vary depending on the state in which you operate. For example, some state laws require membership, board selection and other issues to be stated in the articles of incorporation. To be sure your bylaws are on side with state laws, consult a lawyer before you begin.
Bylaws can help protect your directors and officers from personal liability. For example, your nonprofit can protect its directors and officers from costs arising from wrongful lawsuits by including provisions regarding indemnification in your bylaws.
In some cases, nonprofits are required to indemnify directors and officers, that is, protect and defend them from loss or harm resulting from risk. In other cases, they are prohibited from doing so. (In California, see California codes 5238 and 9246 for more details).
Here’s an example: A nonprofit is required to indemnify a director or officer for all costs the director incurred in successfully defending himself against a lawsuit. In such a case, issues could arise regarding the nonprofit’s ability to advance funds to the director to pay for defense, or its ability to reimburse the director for losses as required by law. For this reason, insurance is necessary. This topic is discussed in more detail in Legal.
Purchasing Directors and Officers Liability Insurance (D&O Insurance) will enable your nonprofit to indemnify your directors and officers. And, in the case of nonprofits that have enough assets to indemnify directors and officers out of the nonprofit’s funds, insurance will reimburse your nonprofit for funds advanced for legal defense. D&O Insurance can also pay for losses incurred against which the nonprofit is not permitted by statute to indemnify.
In fact, if your nonprofit is not able to offer this protection you may run the risk of being unable to recruit qualified directors.
D&O Insurance does two things:
- It directly reimburses directors for legal costs they incur which the nonprofit cannot or will not pay.
- It reimburses the nonprofit for the costs it incurs in indemnifying directors.
Before you sign on the dotted line, consider having your attorney or nonprofit insurance specialist explain your policy in detail.
Be sure to ask:
- Does the policy automatically cover directors and officers who come on after the policy has taken effect?
- Does the policy provide for the advancement of funds to pay defense costs as they come due?
- Is there coverage for claims arising from events occurring before the beginning of the policy period?
- Does the policy provide coverage for employment practices liability?
- What are the limits and deductibles?
Adapted in part from The Nonprofit Board’s Guide to Bylaws, by D. Benson Tesdahl (BoardSource, 2003).