| Printed Page 4300, Apr. 12 | Printed Page 4320, Apr. 12 |

Depending on the status of state law, section 8.30 will replace, modify, clarify or set forth the basic standards that govern the conduct of directors of nonprofit corporations. The standards set forth in section 8.30 are the exclusive standards that govern such conduct. While the exact meaning and application of these standards is left to court decisions, section 8.30 provides the basis upon which these decisions can be made. Except in subsection (e), the Model Act adopts the language used in the Model Business Corporation Act.

States adopting the Model Act may have statutory or common law rules that might apply a trust rule to director conduct covered by section 8.30. Section 8.30 preempts these rules even though the corporation, as distinguished from its director, may hold or be deemed to hold property in trust or subject to restrictions.

While the same language is used, the language is so broad and the differences between public benefit, mutual benefit, religious and business corporations so significant that different factors are relevant in determining whether the standards have been met. A business corporation operates to maximize profits and to economically benefit shareholders. The object of mutual benefit corporations is to provide benefits to and services for members, not to maximize profits. Members may have an economic or noneconomic interest in mutual benefit corporations. Public benefit and religious corporations are quite different. They operate for a public, charitable or religious purpose, not to maximize profits. Their members' interest is not economic but directed toward the corporations' public, charitable or religious purposes. Due to the different nature and objectives of nonprofit corporations, directors of public benefit, mutual benefit, religious and business corporations are not in like positions or operating under similar circumstances.

2. Duty of Care

Section 8.30(a) requires that a director in discharging his or her duties act with the care of an ordinarily prudent person in a like position under similar circumstances. This familiar language allows directors of nonprofit corporations to exercise their judgment with due regard to the nature, operations, finances, and objectives of their organizations. The

Directors must spend enough time on the corporation's affairs to be reasonably acquainted with matters demanding their attention. Such attention involves attendance at meetings and review and understanding of material submitted to the board. It also requires directors to request and receive sufficient information so that they may carry out their responsibilities as directors.

In appropriate circumstances the duty of care requires reasonable inquiry. Where a problem exists or a report on its face does not make sense, a director has a duty to inquire into the surrounding facts and circumstances. The inquiry required is the inquiry an ordinarily prudent person in a like position would make under similar circumstances.

The concept of "in a like position" takes into account the fact that directors of nonprofit and business corporations are not in like positions, but have different goals, objectives and resources. For example, many nonprofit corporations operate with little financial backing. Their directors might reasonably conclude that more risks or less risks were justified due to the precarious financial condition of the corporation. Similarly, foundation directors could reasonably conclude that all or a certain percent of the foundation's grants should go to untried and innovative programs with little chance of success, but that would result in significant benefits if successful.

Two distinguishing factors of nonprofit corporations are that their directors may be serving without compensation and are attempting to promote the public good. Courts may take these factors into consideration in determining whether directors are liable with respect to performance of their duties. This does not mean that directors can ignore their responsibilities because they are volunteers or have no economic interest in the corporation or its operations.

The concept of "under similar circumstances" relates not only to the circumstances of the corporation but to the special background, qualifications, and management experience of the individual director and the role the director plays in the corporation. In many public benefit

Similarly the role of employee-directors should be considered in determining liability under section 8.30. They are the individuals upon whom volunteer directors should be able to rely. See discussion of "Reliance" infra. Their role is crucial to the functioning of many nonprofit corporations. They should be expected to have a more complete grasp of the corporation's activities and should be expected to play an active role in monitoring, problem solving, and decision-making.

A court should not be harsh in second-guessing directors who in good faith make a judgment that proves incorrect. "Although some decisions turn out to be unwise or the result of a mistake of judgment, it is unreasonable to reexamine these decisions with the benefit of hindsight. Therefore, a director is not liable for injury or damage caused by his decision, no matter how unwise or mistaken it may turn out to be, if in performing his duties he met the requirements of section 8.30." Official Comment to Section 8.30 of the Model Business Corporation Act.

3. The Business Judgment Rule

Although it may seem anomalous to apply the business judgment rule to nonprofit corporations, a few courts have so applied it. Yarnall Warehouse & Transfer Inc. v. The Three Ivory Brothers Moving Company, 226 So. 2d 887 (Fla. Dist. Ct. App. 1969). See Beard v. Achenbach Memorial Hospital, 170 F.2d 859 (10th Cir. 1948).

While the application of the business judgment rule to directors of nonprofit corporations is not firmly established by the case law, its use is consistent with section 8.30. Moreover, in the nonprofit context the business judgment rule should apply to discretionary matters voted upon by the board of directors and not just those that can be characterized as "business" decisions. Decisions relating to funding a project or organization, determining what play to produce or what animals to have in a zoo could all fall within the business judgment rule.

4. Duty of Loyalty

The general duty of loyalty of directors of nonprofit corporations is set forth in the mandate of section 8.30 that directors act in good faith in a manner they reasonably believe to be in the best interests of the corporation. Development of standards in this area is left to judicial resolution. See Mile-O-Mo Fishing Club, Inc. v. Noble, 62 Ill. App. 2d 50, 210 N.E.2d 12 (1965).

Sections 8.31-8.33 deal with particular aspects of the general duty of loyalty. In setting forth the general standards in section 8.30 and particular standards in sections 8.31-8.33, it is the intent of the Model Act to reject the strict trustee standards and to set forth the exclusive standards under which courts should resolve duty of loyalty questions. In some states it may be necessary to negate the application of various code sections that might otherwise improperly be applied to nonprofit corporations.

5. Good Faith

A precondition to a director discharging his or her duties is that the director act in good faith. While this is a subjective requirement, a court will look to objective facts and circumstances to determine whether the good faith requirement is met. A court generally will look to the director's state of mind to see if it is evidenced honesty and faithfulness to the director's duties and obligations, or whether there was an intent to take advantage of the corporation. A director of a religious corporation in making a good faith determination may consider what the director believes to be: (1) the religious purpose of the corporation; and (2) applicable religious tenets, canons, laws, policies and authority.

6. Reasonable Belief That Action Is in the Best Interests of the Corporation

The requirement that the director act in a manner the director reasonably believes is in the best interests of the corporation is both objective and subjective. It is objective in that the director must reasonably believe the action is in the best interests of the corporation. It is subjective in that the director must in fact believe the action is in the best interests of the corporation. As with the good faith requirement, a court is likely to look to objective facts to determine whether a director's state of mind appears unreasonable and whether the director really believed that the action was in the best interests of the corporation.

So long as a director does not have knowledge that would make reliance unwarranted, a director may rely on information, opinions, reports, and statements prepared and presented by the individuals and committees specified in section 8.30(b). The right to rely is based on the practical need of directors of nonprofit corporations to rely on experts, staff, committees composed in whole or part of non-board members and committees of the board. With one exception a director may only rely on information from individuals or committees who the director believes to be competent. See section 8.30(b)(1) and (2). Under section 8.30(b)(3) in relying on committees of the board of which the director is not a member, the director must believe that the committee merits "confidence," not that it is "competent." "In section 8.30(b)(3), the concept of `confidence' is substituted for `competence' in order to avoid any inference that technical skills are a prerequisite." Official Comment to Section 8.30 of the Model Business Corporation Act. The requirement that a director must not have knowledge that would cause reliance to be unwarranted means that a director cannot rely on that which he or she knows to be unreliable.

In most circumstances a director is entitled to rely on reports prepared by the individuals or committees specified in subsection (b). Where, however, a director has a reasonable basis to be suspicious or is in fact suspicious, the general duty of care set forth in section 8.30 requires the director to make further inquiry. In addition to the requirement that a director must reasonably believe that the material is reliable, the director must in fact rely on the material. In order to rely on a report a director must have read it, been present at a meeting where it was presented or otherwise have evaluated it.

8. Delegation

Directors of a nonprofit corporation may delegate authority to officers, employees or agents of the corporation so long as the affairs of the corporation are managed under the direction of the board. See section 8.01(b). "Since the board may delegate or assign to appropriate officers of the corporation the authority or duty to exercise powers that section 8.01 does not require the board to retain, directors are not personally responsible under section 8.30 for actions or omissions of officers, employees, or agents of the corporation so long as the directors, complying with the standard of care set forth in section 8.30, have acted reasonably in delegating responsibility." Official Comment to Section 8.30 of the Model Business Corporation Act.

Section 8.30(d) is based in part upon section 8.30(d) of the Model Business Corporation Act which was based on section 35 of the prior Model Business Corporation Act. Section 8.30(d) is "self-executing, and the individual director's exoneration from liability is automatic . . . .

Section 8.30(d) makes clear that the section will apply whether or not affirmative action was in fact taken. If the board of directors or a committee considers an issue (such as a recommendation of independent auditors concerning the corporation's internal accounting controls) and determines not to take action, the determination not to act is protected by section 8.30. Similarly, if the board of directors or committee delegates responsibility for handling a matter to subordinates, the delegation constitutes `action' under section 8.30. Section 8.30(d) applies (assuming its requirements are satisfied) to any conscious consideration of matters involving the affairs of the corporation. It also applies to the determination by the board of directors of which matters to address and which not to address. Section 8.30(d) does not apply only when the director has failed to consider taking action which under the circumstances he is obliged to consider taking." Official Comment to Section 8.30 of the Model Business Corporation Act.

Subsection (d) deals with one area of potential liability that is not explicitly dealt with by section 8.30 of the Model Business Corporation Act. It provides that a director who has acted in compliance with section 8.30 "is not liable to the corporation, any member or any other person for any action taken or not taken as a director. . . ." This provision protects directors from claims by third persons. It rejects the holding in Frances T. v. Village Green Owners Ass'n., 43 Cal. 3d 490 (1986). However, a director who personally commits a tort is not protected by the provisions of section 8.30.

Subsection (e) deals with another area of potential liability that is not explicitly dealt with by section 8.30 of the Model Business Corporation Act. Subsection (e) provides that a director is not a trustee with respect to the corporation or any property held by it. Absent subsection (e), it would be possible to argue that a director meeting his or her duties under section 8.30 was liable for a breach of trust by improperly using, disposing of, or otherwise dealing with assets held by the corporation in trust. As a result of subsection (e) this argument has no vitality. A director who meets the standard of section 8.30, but improperly acts or fails to act in regard to property held in trust, will not be liable. Depending on state law, the corporation may be liable for breach of trust.

10. Investments

Numerous states have adopted the Uniform Management of Institutional Funds Act. That act deals with the way in which nonprofit organizations hold, manage, and invest their assets. In adopting the Model Act states should consider the applicability of the Uniform Management of Institutional Funds Act to the standards set forth in sections 8.30-8.33.
SOUTH CAROLINA REPORTERS' COMMENTS

This section replaces formerly applicable statutory law found at Section 33-8-300 of the South Carolina Business Corporation Act and changes prior law in several ways.

Subsection (a)(3) omits the words "and its shareholders" found in the Business Corporation Act. The function of this section is solely to establish the standard of care with which directors must act in fulfilling their duties, in order to avoid personal liability. To whom duties are owed by directors is a matter of common law. That directors owe duties to shareholders and members of corporations is well established in South Carolina by common law, reviewed in the South Carolina's Reporter's Comments to Section 33-8-300.

Subsection (b)(3) differs slightly in wording from the analogous provision of Section 33-8-300. This difference is intended for clarification and not to make any substantive change in meaning.

Subsection (b)(4) is new, adding an additional category of reliable expert for religious organizations.

Subsection (d) differs slightly in wording from the analogous provision of Section 33-8-300. The new wording is intended to make clear that directors who, acting as directors, comply with the standard of care of this section, are shielded from liability to any person to whom a court might find that the director, acting as a director, owed a duty. See paragraph 9 of the Official Comment. Subsection (d) is not intended to create any duty which did not previously exist or to suggest that such a duty should exist.

Subsection (e) is new. Its intent is to make clear that directors are not trustees by virtue of their directorships alone. This is true even if corporate governance documents refer to the directors as trustees. Directors may otherwise be made trustees in connection with their directorships, however. Concerning the statutory duty of a trustee versus that of a director, compare Section 62-7-302(a) with Section 33-8-300.

This section does not address the business judgment rule. The business judgment rule would be available to a director as a defense notwithstanding such director's inability to establish a defense under this

Subsection (f), which was not proposed in the Model Act, was added to correspond to former law found at Section 33-8-300(d) of the South Carolina Business Corporation Act. Subsection (f) is intended to provide for limitations periods similar to those found in Section 33-8-300(d), but has been altered in substance to reflect the absence of the concept of duty from this section.

Concerning the power of corporations to limit the personal liabilities of their directors, see Section 33-31-202(b).

Section 33-31-831. Director conflict of interest.

(a) A conflict of interest transaction is a transaction with the corporation in which a director of the corporation has a direct or indirect interest. A conflict of interest transaction is not voidable or the basis for imposing liability on the director if the transaction was fair to the corporation at the time it was entered into or is approved as provided in subsections (b) or (c).

(b) A transaction in which a director of a public benefit or religious corporation has a conflict of interest may be:

(1) authorized, approved, or ratified by the vote of the board of directors or a committee of the board if:

(i) the material facts of the transaction and the director's interest are disclosed or known to the board or committee of the board; and

(ii) the directors approving the transaction in good faith reasonably believe that the transaction is fair to the corporation; or

(2) approved before or after it is consummated by obtaining approval of the:

(i) Attorney General; or

(ii) the circuit court for Richland County in an action in which the Attorney General is joined as a party; or

(c) A transaction in which a director of a mutual benefit corporation has a conflict of interest may be approved if:

(1) the material facts of the transaction and the director's interest were disclosed or known to the board of directors or a committee of the board and the board or committee of the board authorized, approved, or ratified the transaction; or

(2) the material facts of the transaction and the director's interest were disclosed or known to the members and they authorized, approved, or ratified the transaction.

(1) another entity in which the director has a material interest or in which the director is a general partner is a party to the transaction; or (2) another entity of which the director is a director, officer, or trustee is a party to the transaction.

(e) for purposes of subsections (b) and (c) a conflict of interest transaction is authorized, approved, or ratified if it receives the affirmative vote of a majority of the directors on the board or on the committee who have no direct or indirect interest in the transaction, but a transaction may not be authorized, approved, or ratified under this section by a single director. If a majority of the directors on the board who have no direct or indirect interest in the transaction vote to authorize, approve, or ratify the transaction, a quorum is present for the purpose of taking action under this section. The presence of, or a vote cast by, a director with a direct or indirect interest in the transaction does not affect the validity of any action taken under subsections (b)(1) or (c)(1) if the transaction is otherwise approved as provided in subsection (b) or (c).

(f) For purposes of subsection (c)(2), a conflict of interest transaction is authorized, approved, or ratified by the members if it receives a majority of the votes entitled to be counted under this subsection. Votes cast by or voted under the control of a director who has a direct or indirect interest in the transaction, and votes cast by or voted under the control of an entity described in subsection (d)(1), may not be counted in a vote of members to determine whether to authorize, approve, or ratify a conflict of interest transaction under subsection (c)(2). The vote of these members, however, is counted in determining whether the transaction is approved under other sections of this chapter. A majority of the voting power, whether or not present, that are entitled to be counted in a vote on the transaction under this subsection constitutes a quorum for the purpose of taking action under this section.

(g) The articles, bylaws, or a resolution of the board may impose additional requirements on conflict of interest transactions.
OFFICIAL COMMENTS

1. Applicability of Section 8.31

Section 8.31 applies to a limited category of conflict of interest transactions. Section 8.31 applies to a transaction if a director: (1) has a direct interest in the transaction; (2) is a general partner in a partnership or a director, officer or trustee of another entity that has an interest in the transaction; or (3) has a material interest in an entity that has an interest

Even if section 8.31 does not apply to a transaction, section 8.30 may be applicable. For example, a director of a nonprofit corporation may have an immaterial interest in an entity that has a contract with the director's nonprofit corporation. Section 8.31 would not apply as the director's only interest in the transaction is an immaterial interest. However, the general duty of loyalty set forth in section 8.30 would apply. The director would have to act "in good faith . . . in a manner the director reasonably believes to be in the best interests of the corporation." Section 8.30(a)(1) and (3).

Section 8.31, like section 8.30, rejects the trust standard. That standard prohibits any transaction between a trust and a trustee. Section 8.31 also rejects the concept that director may not obtain any profit from a transaction involving his or her corporation. If the requirements of section 8.31 are met, a director can make a profit from a transaction involving his or her corporation.

The Model Act recognizes that many individuals are elected to nonprofit boards because of their ability to enter into or cause an affiliate to enter into a transaction with and for the benefit of the corporation. Often landlords, lawyers, bankers, and suppliers are added to a board so the corporation can obtain reduced rent, free or low-cost legal services, loans, and bargain purchases. Ideally, nonprofit corporations would have sufficient money to carry out their purposes and would not have to rely on or plead for favorable treatment. As a practical matter this does not often concur. Therefore the Model Act attempts to provide a tolerable accommodation between the needs of nonprofit organizations and the potential abuses of directors or officers.

2. Ways to Comply With Section 8.31

a. Public Benefit and Religious Corporations

There are four ways in which a transaction involving a public benefit or religious corporation may meet the requirements of section 8.31.

First, a transaction that is fair to the corporation at the time it is authorized or is entered into does not violate the provisions of section 8.31. Consequently an interested director may always defend a claim that a transaction violates section 8.31 by showing it was fair to the corporation.

The essence of the fairness test is set forth in Pepper v. Litton, 308 U.S. 295, 306 (1939), where the Court stated that in evaluating the fairness of transactions entered into by a corporation and its directors or controlling persons:

| Printed Page 4300, Apr. 12 | Printed Page 4320, Apr. 12 |