Two children of the founders of a family private foundation don’t seem to see eye-to-eye on the operation of the foundation they now lead following the death of their parents.  The Seventh Circuit Court of Appeals has recently affirmed a District Court decision denying relief to the son who sought to overturn actions taken by his sister.  (See Nonprofit Issues, 1/16.) 

The Court of Appeals has held that the son, as a director of the Indiana nonprofit corporation, cannot bring a derivative action on behalf of the foundation to recover grants approved by his sister.  It has also held that a third director did not lose her place on the board when her term expired without the election and qualification of a successor.  And it has held that there was no impermissible conflict in the sister’s approving grants to the University of Saint Francis of Fort Wayne on whose board she sits.

The foundation was originally formed in 1990 with the two parents and their two children, Richard Doermer and Kathryn Callen, were named directors for life.  The mother died in 2000 and in January, 2010 the board elected Phyllis Alberts to a three-year term as a director.  The father died in October 2010, leaving three directors, with Phyllis Alberts’ term expiring in January 2013.

Under Indiana law, a nonprofit corporation must have at least three directors.  But state law provides a “safety valve,” the Court said, providing that when a director’s term expires without further action by the board, “the director continues to serve until … a successor is elected, designated, or appointed and qualifies.”  The foundation’s bylaws also stipulated that a director would serve for three years “and until her or his successor is elected and qualified.”

In September 2013, pursuant to a resolution and bylaws, Kathryn and Phyllis voted to elect Phyllis for a second term.  Richard opposed the election and a number of actions taken by the board over his objection.  After the board elected John Callen, Kathryn’s son, as an additional member of the board, Richard brought suit, both as a derivative action on behalf of the foundation and in his own right as a director.

The District Court granted the defendants’ motion to dismiss and the Court of Appeals has affirmed.

The Court said that a derivative action on behalf of the corporation had to be brought by a “member” of the corporation, and could not be brought by a director.  A “member” of a corporation is roughly analogous to a shareholder of a business, usually having the right to vote for or remove directors.  Reviewing the statute and a series of cases in the state, the Court concluded that “the [Indiana] Nonprofit Corporation Act does not authorize, nor have Indiana courts suggested they would approve, a non-member director’s derivative action.”

On his individual claims, the Court said his claim for money damages had to fail because he is the wrong party to bring the claim.  Essentially, he had suffered no personal loss, and if the foundation suffered a loss, he did not have the standing to bring the derivative action on behalf of the foundation to recover it.

He also sought injunctive relief, citing two different sections of the statute as his authority.  The first section, however, permitted a court to remove a director for misconduct in a proceeding brought by “at least 10% of the members” entitled to vote for the director.  Again the Court said there were no members of the corporation and no basis for such removal.

The second section permits a director to seek to enjoin an action where a third party has not acquired rights.  But even if he had a right to sue under this provision, the Court said, he had not pled a plausible basis to justify relief.  “His complaint turns on two faulty theories of corporate wrongdoing,” the Court said.

Richard argued that Phyllis Alberts’ term expired in January, 2013 and that everything done thereafter with only two directors was invalid because he opposed and nullified his sister’s vote, and because the foundation was acting without the statutorily required three directors.

The Court cited the statute, the bylaws, and the resolution electing Phyllis to the board for the proposition that she remained a director until such time as her successor was elected and qualified.

It also said that Richard had no cause of action from the allegation that Kathryn was “conflicted” in approving a grant to Saint Francis where she also serves on the board.  “Richard has not identified any authority for the proposition that, merely by voting in favor of a charitable contribution from one nonprofit organization to another, Kathryn somehow breached a fiduciary duty or committed some other wrong.  Richard cannot cite a case, a statute, a regulation, or even a provision of the corporate instruments that would render Kathryn’s vote unlawful.”

The state law “does not expressly immunize a ‘conflicted’ director, but it provides that a transaction between two nonprofit corporations is not void or voidable solely because a director who votes to authorize the transaction serves on the boards of both corporations.  With no explanation from Richard as to why Kathryn’s approval of the gifts to Saint Francis was impermissible, and with clear statutory guidance showing that the transaction itself could survive irrespective of any ‘conflict,’ Richard’s final theory of corporate wrongdoing is without merit,” the Court concluded.  (Doermer v. Callen, 7^th Cir., No. 15-3734, 2/1/17.)

YOU NEED TO KNOW

Here is what we said when we reported this case at the District Court level:

Despite the law giving directors the right to vote on grants to organizations on whose boards they serve, many grantmakers have internal conflict of interest policies that require directors to recuse themselves where such a conflict exists.  They don’t want the appearance of favoritism that can result from such grants.  Where there is a large board, it probably doesn’t make any difference so long as there is general support for the grant among the other board members.  But with a board of only four, the conflict policy could prevent the grant on the basis of a single negative vote if a grant required the affirmative vote of a majority of the directors.  It wouldn’t prevent the grant if the bylaws provided that the directors could act by majority vote.   This is another instance where the voting language of the bylaws can be critical in the outcome, but it is not always considered carefully in drafting governing instruments.