Indiana Nonprofit Corporations – What is Indemnification?

From the email inbox:

Our nonprofit Board has been talking about getting D&O insurance.  Our bylaws says that the nonprofit must indemnify the Board of Directors.  What is indemnification, and why do we need D&O insurance?

ANSWER:

This is a complicated issue that generates a lot of questions.

“Indemnification” and “Directors & Officers” insurance (also known as D&O or “errors and omissions” insurance) are related, but two separate things.

OK – here’s an overview of how each works:

1.  The State of Indiana (in Indiana Code 23-17-13-1(d)) provides protection for nonprofit organizations and their board members (not general members) for actions taken in good faith in the execution of their duties the normal course of their activities.

2.  It is important for the nonprofit organization’s bylaws to reflect this by adding indemnification language (Indiana Code and 23-17-16-1, et seq.), so that protection is acknowledged and enforced at the Board (organization) level.  Smart board candidates refuse board service with an organization that does not include indemnification language in the Bylaws.  (More on Directors & Officers insurance, in a minute).

— This means that if a Board member is sued for actions of the Board or of the organization, then the Board member is covered by Indiana law with the same protection provided to nonprofits.

— Generally speaking, if a nonprofit organization is sued, the Board members are included in the lawsuit – by name – as a matter of course.  That’s just how the shot-gun approach to lawsuits works.

— By the way, this language is typical for all types of corporations – this is not just peculiar to nonprofits.  ALL formal organizations use (or should use) indemnification language  in the bylaws.

3.  A separate question is whether a nonprofit organization should purchase Directors & Officers insurance (D&O).

— Most of the time, if there is a claim, the purpose of D&O is to pay for the attorney to defend the lawsuit.   Generally, the State protection for nonprofits will prevent a claim from being successful, but will not prevent a claim from being filed (anyone can sue anyone for anything – but that does not mean that “anyone” will win).  That said, lawyers are expensive, so there is value in the insurance, from that perspective.

— However, there are instances where there might be a successful claim, and this is why D&O insurance is important.    This is usually in situations where a board decision has either consequences that affect someone’s livelihood or income, or has tragic consequences.  I use the example of an experimental aircraft club.  The Board’s decision to allow (or not) a particular experimental aircraft to fly into an event could have tragic consequences.  A more mainstream example would involve organizations that benefit “protected classes” – the young, the elderly, the disadvantaged, the disabled, etc.  A Board decision that has a negative impact on the life (or quality of life) of a protected class could result in a lawsuit.

— Another example would be a nonprofit that handles significant amounts of money or distributes a significant amount of money or assets that might be an attractive target for a lawsuit.  A typical use of D&O is for economic development organizations that work on development projects that can be worth millions of dollars.

— Small nonprofits that fit none of these trigger points might choose to forgo D&O insurance.  This should be a board discussion and a cost-benefit analysis (the cost of D&O weighed against the relative risk of a lawsuit)