Policy Bites: Why Cooperatives Should Adopt Ethics and Confidentiality Agreements for their Board of Directors.
Many of us already know that housing cooperatives are made up of the entire membership. By this token, cooperatives are inherently diverse. Since a cooperative’s Board of Directors typically consists of a group of members elected by the entire membership, its Directors are usually equally diverse and important as the entire membership that makes up the cooperative. There are several important characteristics, traits, and duties that each director holds as a position of trust and fiduciary to the corporations they serve. It is important for Cooperatives to understand these duties and the extent upon which they bestow obligations to each director. A good approach to doing this is for a cooperative to adopt certain ethics, conduct and confidentiality policies, and for their Directors to execute agreements avowing their fiduciary duties and obligations to the cooperative. These policies and agreements should strengthen the sense of loyalty and ethical conduct of the Directors, and add a sense of transparency. In addition, they may also insulate the Cooperative from potential liability from legal claims and challenges to official Board actions.Directors are fiduciaries and owe certain duties and responsibilities to the Cooperative and membership
Typically guided by state law, a Director is considered to hold a fiduciary position of which that director owes several duties to the corporation of which they serve. For example, in Michigan (see M.C.L. § 450.2541) the Nonprofit Corporation Act sets forth three distinct duties that every director’s standard of conduct must conform to when serving on a nonprofit corporation, such as the makeup of many Cooperatives. This law states that Directors must act:
- In good faith (the “duty of good faith”);
- With the care an ordinarily prudent person in a like position would exercise under similar circumstances (the “duty of care”); and
- In a manner he/she reasonably believes is in the best interests of the corporation (the “duty of loyalty”).
These duties (of good faith, of care, and of loyalty) apply to each individual director of the corporation. Each duty is unique and involves different standards and conduct. However, the overall theme of each duty is that the director is serving the best interests of the corporation.
Duty of Good Faith and Duty of Care
The duty of good faith stands for the principle that when deciding on behalf of the corporation, directors, and officers must act with a conscious regard for their fiduciary duties. Directors and officers must act to benefit the cooperative and do so without violating the law. This concept of “good faith” can also be understood by terms such as acts of honesty, having an honest intention, sincerity, and fair dealing.
States typically incorporate these duties into law. For instance, Michigan law provides that directors of nonprofit corporations must discharge their duties both in good faith and with the same degree of diligence, care, and skill in which that of an ordinarily prudent person in the same position would exercise under similar circumstances. (see M.C.L. § 450.2541(1)(a), (1)(b)). This statute, for example, creates a new standard for Directors’ conduct – i.e., the “ordinarily prudent person standard.” This standard does not mean that Directors should merely act as an “average” person. Nor does this standard mean to set a minimum requirement that actions of directors and officers be “mediocre.” Rather, the Ordinary Prudent Person Standard acknowledges that a director is not an expert, nor required or expected to have a specific set of technical or specialized expertise in an area in which the director is acting. Instead, this standard means that directors are expected to have and utilize “sound, practical judgment and common sense” and to reach informed decisions and conclusions when acting on behalf of the corporation.
Directors should exercise diligence in the performance of their duties. Exercising diligence is part of exercising due care. Examples of exercising diligence include reading and becoming familiar with the Cooperative’s governing documents including any updates or amendments, regularly attending meetings of the board and of the membership, seeking professional opinions from professional agents such as its accountants, lawyers, and property managers. Seeking and relying on information obtained from professional agents of the corporation (accountants, lawyers, etc.) establishes a record, and evidence, that a director acted diligently – i.e., relying on information and opinions of professionals will help show that the director(s) acted in both good faith and with a duty of care to the corporation.
Duty of Loyalty
The duty of loyalty speaks for itself. Directors must act in the best interest of the Cooperative. This duty requires Directors to discharge their duties with the sort of undivided devotion and commitment to the Cooperative. The interests of the Cooperative should come first. Directors may not place their individual interests, or the interests of any third parties (i.e., family members, relatives, friends, personal or business acquaintances, or other business entities with which that director has any form of pecuniary interest in) above the interest of the Cooperative. Why is this? Members of the Board are privy to important, sensitive and confidential information of the Cooperative and its membership. The duty of loyalty ensures that the directors will not use this information for personal gain or for the gain of others which the director may have an interested in.
The duty of loyalty works to prevent situations involving conflicts of interest. Typical examples of transactions involving conflicts of interest are when a cooperative engages or contracts with a third party and where a Director has a relationship or pecuniary interest with that third party. These situations set the stage for classic examples of “conflicts of interest” or “identities of interest.” If such a transaction occurs where identity or conflict of interest is not first disclosed, and the interested director does not abstain from exercising influence over, the transaction may be subject to legal challenges or be set aside. In Michigan for example, the Nonprofit Corporations Act provides that:
- A transaction in which a director or officer is determined to have an interest shall not be enjoined, set aside, or give rise to an award of damages or other sanctions because of the interest, in a proceeding by a shareholder, a member, or a director of a corporation that is organized on a directorship basis or by or in the right of the corporation, if the person interested in the transaction establishes any of the following:
- The transaction was fair to the corporation at the time it was entered into.
- The material facts of the transaction and the director’s or officer’s interest were disclosed or known to the board or an executive committee of the board and the board or executive committee authorized, approved, or ratified the transaction.
- The material facts of the transaction and the director’s or officer’s interest were disclosed or known to the shareholders or members who are entitled to vote and they authorized, approved, or ratified the transaction.” (M.C.L. § 450.2545a).
Common instances involving violations of the duty of loyalty occur when the Cooperative, through the acts of its Board, transacts with a third party and a Director fails to disclose a conflict of interest or identity of interest with that third party. The duty of loyalty aims to avoid these situations, and if there is an interest, that the Director who may have an interest is precluded from exercising influence over the transaction. Therefore, disclosing identities or conflicts of interest are acts that fall in line with a director’s duty of loyalty to the cooperative. No matter the degree of connection between the director and third party, it is important that all such conflicts of interest and identities of interest be disclosed in writing, and that any interested director abstains from exercising any influence over the corporation’s actions as they relate to that transaction.
Best practices dictate that directors should be personally and financially disinterested from the third-party contractors, organizations or entities that may serve the corporation, to the greatest extent possible while serving the best interest of the cooperative. To protect the cooperative and its directors from liability and challenges, it is best for the Board of Directors and the Cooperative to adopt policies or rules that address situations where a conflict of interest or identity of interest arises. A sound policy will set out procedures and requirements for board members to disclose material facts, identities of interest or potential conflicts of interest in transactions. These procedures should also provide that the director abstains from exercising any action or influence over the transaction and will otherwise maintain confidentiality of information that the director possesses. A well-rounded policy should address three main areas: (i) awareness; (ii) disclosure; and (iii) disinterested review of the transaction.Other Fiduciary Duties
In addition to the duty of care and duty of loyalty, directors and officers must also abide by the duty to maintain confidentiality of information of the cooperative. This is commonly referred to as the “duty of confidentiality.” As a general rule, unless the information has been released to the public or to the entire membership, directors should treat the information of the cooperative, and its members, as private and confidential. Violations of the duty of confidentiality may jeopardize opportunities and foster an environment of mistrust amongst the members, the board of directors, officers and residents of the community. Cooperatives should look to adopting certain policies regarding the confidentiality of certain information, and having directors and officers execute agreements acknowledging that the confidences of the cooperative will, and must remain confidential.Incorporating Fiduciary Duties into Policies and Agreements
The duty of good faith, duty of care, duty of loyalty and duty of confidentiality exist to protect the cooperative and its well-being. A Cooperative does not run itself – it is run by a group of individuals. Cooperatives are comprised of its entire membership who elect its Board of Directors. The Directors serve as integral parts in the existence, conduct and continued sustainability of the cooperative. Incorporating policies that include the duty of good faith, duty care, and loyalty will not only best serve the community, but will also help protect the corporation and its individual directors and officers from certain liabilities.
Agreements that encompass and incorporate these duties are examples of best practices on how a cooperative can ensure that its Directors act with due care and in the best interest of the cooperative. Each Director should have an understanding of these duties, how they impact and dictate corporate action, and adopt practices and policies to address these matters. Having these duties encompassed in a written policy and agreement helps strengthen the cooperative, its Board of Directors, and membership.Please note this content is provided to our readers for educational purposes but it is not intended and should not be regarded as legal advice. Readers are encouraged to consult with competent legal counsel for personalized guidance.